LabCFTC Publishes Smart Contract Primer

LabCFTC, the Commodity Futures Trading Commission’s (CFTC’s) FinTech initiative, earlier this week published a primer on smart contracts.  The primer defines smart contracts and explains some of their key attributes, discusses the CFTC’s role in regulating smart contracts, outlines some potential benefits and use cases and warns market participants of potential associated risks.

The primer explains that a smart contract is a set of coded functions that may incorporate elements of a binding contract.  A smart contract also directs self-executing computer code to take action at specified times or at the occurrence or non-occurrence of an action or event.  Smart contract storage and execution can also take place on a blockchain-based distributed ledger that deploys evidence of the smart contract to nodes on the network.

The CFTC, echoing some of the themes from CFTC Commissioner Brian Quintenz’s recent speech on smart contracts, warns that depending on the structure, operation and relevant facts and circumstances, a smart contract could represent a product that is subject to CFTC jurisdiction.  Therefore, market participants using such smart contracts, including smart contracts deployed on a decentralized blockchain, would be required to comply with appropriate CFTC regulations, along with other relevant regulatory frameworks.

Additionally, the primer outlines some of the potential benefits of smart contracts, including standardization, security, economy and speed, certainty and business and regulatory innovation.  The document also provides some example uses cases for smart contracts, including self-executing insurance policies, transportation rentals and credit default swaps.  Other potential use cases highlighted in the primer include streamlining post-trade processes and margin calls for derivative contracts, automated dividends and stock splits, trade clearing and settlement, supply chain and data reporting. 

However, the primer warns of some potential drawbacks associated with smart contracts, including their potential to circumvent regulation, limit transparency, impair market integrity, pose cybersecurity and operational risk and be subject to fraud and manipulation.

There are a number of smart contract projects currently being developed by innovators and industry bodies (e.g. the International Derivatives and Swaps Association’s Common Domain Model).  The primer represents LabCFTC’s efforts to stay in step with market innovations and engage with innovators and market participants on regulation and best practices associated with novel technologies.  Going forward, we will continue to follow any additional publications and statements by the CFTC and other regulators in respect of smart contracts and smart contract regulation.