1.   Introduction

Financial technologies are typically comprised of payments, insurance, deposit and lending, capitalisation, investment management, and market provisioning, and each one of these sub sectors has distinct attraction to present significant challenges (Chishti et al., 2016). This paper is divided into three sections: Firstly, the paper will start by addressing the issues in one of the financial subsector, the traditional payment clearance system of retail banking. Second, it examines several statutes applicable to smart contracts for payment clearing and critically analyses the advantages, disadvantages, risks, and technology’s disruptive impact involved. Finally, conclude the paper by providing predictions, implications, and recommendations of using smart contracts.

2.   Traditional payment clearance system and Smart Contracts

Retail banking is mainly accountable for keeping consumers money in a secure manner by maintaining multiple procedures and mediators, and that leads to cause the entire payments clearance system being quite slow and costlier. The inclusion of manual procedures and human intervention makes the banking sector susceptible to errors, risks, and fraudulence (Vega, 2021). The following issues in the traditional payment clearing system (in the context of backend process) are discussed in the paper and how smart contracts in blockchain based applications can be used to overcome it:

• Traditional payment clearance takes at least 1 to 3 days in verification between two parties due to the legal contract is engaged.
• The banking data stores in multiple locations and therefore, there can be chance to change the data at the same time.
• Cyber-attacks, data leakage and account hacks in the payment clearance system.

According to (Pedersen, 2020, p.160), the global financial crisis turned out between 2007-09 became the crucial turning point for fintech. Post-crisis, traditional financial intermediaries thoroughly examined payment systems to better control the risk. The emergence of alternative mechanisms, such as peer-to-peer, virtual banking, mobile banking, smart contracts, and open banking APIs all serve to offer additional alternatives to customers. Blockchain-based smart contracts have had a major impact on the financial industry in the last few years, resulting in a new crypto economy. Szabo (1994) described smart contracts as a set of promises that can be specified in a digital form and parties act on these promises. It uses computer protocols that facilitate, verify, and automatically enforce information transfer for the negotiation and agreement among multiple untrustworthy parties (Pedersen, 2020, p.118). This means that by using smart contracts, information can be more transparent, secure, and reliable between two parties. Blockchain-based applications such as Ethereum, Hyperledger Fabric, r3 Corda, Ripple have smart contracts which overlap traditional contracts by including the terms of agreements between two or more parties. These contracts have the ability to convert paper contracts into digital contracts and execute agreements automatically in a distributed environment based on conditions (Pedersen, 2020, p.160). In order to prevent contract tampering, smart contracts are copied to each node of the blockchain network. By enabling the execution of the operations by computers and services provided by blockchain platforms, human error could be reduced to avoid disputes regarding such contracts (Pedersen, 2020, p.118).

Using smart contracts in the Blockchain-based application can drastically reduce manual interventions by digitising procedures (Giancaspro, 2017). This implies retail banking can start using smart contracts as a possible replacement for traditional business contracts. It would help to improve the efficiency of payment clearance between two parties and reduce manual operational costs (Nzuva, 2019). Consumers and banks are the main trading parties in online payment transactions so smart contracts execute based on conditions to ensure that payments are made within a predetermined time. In the traditional payment system, the intermediary is responsible for ensuring the effective execution of contracts, and many scenarios are guarded by a certain degree of centralisation. Achieving true decentralisation is extremely challenging in real world applications. More centralised consortiums and private blockchains can be derived from a completely decentralised public blockchain (Shin el at., 2016).

3.   Business and Economic disruption that widespread adoption of smart contracts

Payments are tracked by a number of financial institutions using SWIFT (the Society for Worldwide Interbank Financial Telecommunication) and these transactions/payments between two parties are handled through the SWIFT system using a middleman (Chishti et al., 2016, p.206). The banks, however, will not be able to detect if the middleman engages in fraud. Smart contracts can eliminate the need for middlemen in the completion of transactions. The implementation of smart contracts using blockchain technology can eliminate legal personnel (Nzuva,2019) and validate the transactions by the consensus of the network’s users rather than by a trusted intermediary or Escrow services (Giancaspro, 2017). This means that it can reduce transactions costs, as well as provide transparency and confidentially to all parties involved. Smart contracts are based on cryptographic protocols, which allow the code to execute autonomously. The code can be written based on blockchain applications in the coding language like Solidity, Kotlin, Go, Java based on Ethereum, Hyperledger or Corda applications. Transparency and anonymity are two other benefits provided by smart contracts (Nzuva,2019, p.9). In a public ledger, smart contracts are visible to all miners, as there is no central authority or trusted intermediary validating and collating all transactions.

A smart contract is a program that can self-execute and enforce a transaction contract, verify it, or facilitate its performance using a blockchain environment, such as Corda, Ripple (Nzuva, 2019, p.2). In a blockchain-enabled environment, digitalisation and the exchange of financial assets present new ethical challenges. A smart contract can be triggered by events outside of the contract, such as by the Internet of Things (IoT) or Artificial Intelligence (AI). There are many areas where smart contracts can be useful, and studies have been conducted on the use of law, regulations, and private standards in enhancing the sustainability of value chains (Woiceshyn, 2011, p.5). Smart contracts can be sustained and trusted by means of implementation into blockchain based applications (Mengelkamp et al., 2017). This is because blockchains provide guarantees of authenticity of information and a mechanism to enforce representations through smart contracts, blockchains can improve sustainability.

Smart contracts need to be discussed in a wider context than their impact on commercial contracts (Woiceshyn, 2011, p.5). This means that smart contracts can be employed to automate processes to contribute to the area of social corporate responsibility (CSR). In general, social contracts are the foundation for an ideal society based on peer-to-peer relationships rather than government-to-government relationships. In addition, to automate socially accepted rules, smart contracts offer opportunities for new forms of governance through the implementation of new social contracts. This means that there are both challenges and opportunities associated with the digitalization of social contracts and norms. In the information age, updating social contracts is essential to protect human dignity and fulfil human potential (Woiceshyn, 2011). The smart contract cannot be changed or reversed since blockchain ensures that it will execute if the agreed conditions are met. Certain codes can be formulated based on conditions for the transfer of funds for social causes. Although the mind can change, the immutable agreement cannot (Woiceshyn, 2011, p.5). This law obliges businesses to adhere to their promises transparently and permanently. By describing the promise, it is committing to, a bank can set up a smart social contract (SSC). Customers can check on the ledger whether their payment or action has been received by the charity whenever they pay or complete an action. The blockchain based smart contracts have a disrupting applicability to the payment clearance systems by reducing the processing duration and eliminating the third parties for verification.

4.   Conclusion

A single transaction’s efficiency can be influenced by the level of centralization and the use of technology. Due to the simultaneous nature of transaction processing and clearing, each transaction must be verified by all nodes across the network, hindering the speed of the network. The major risk associated with smart contracts is incorrect structuring of the contract through incorrect coding and/or requirements. Cybersecurity protection is insufficient to prevent legislation from being hacked. Since smart contracts are immutable, it is extremely difficult to modify specific clauses. Due to this, the contracts are invulnerable to tampering and offer the best security possible. When a change is made in one system, it does not affect all the other devices in the system; nevertheless, the change will be applied to all connected devices. As a result, the contract is less flexible and difficult to change. Despite this, smart contracts remain widely used worldwide due to their protection function. On the other hand, the immunity to change acts as a barrier between the parties and difficult for the courts to fill the gaps. As smart contracts in Ethereum use “gas” to execute contracts, there is an unnecessary cost for inefficient use of these contracts. This means that by eliminating text-based contractual relationships, smart contracts introduce an additional risk. This increase the likelihood that the contract can be hacked or that the code contains an unintended programming error (Giancaspro, 2017, p.3).

Implications

As a result of weak legal regulations, smart contracts are highly dependent on programmers and are susceptible to bugs and vulnerabilities. Imagine that X and Y are negotiating smart contracts, and Z is adding a step to the chain. As a result, Z must accept the terms and conditions set by X and Y, and not having the option to negotiate their terms and conditions. This violates the most fundamental element of the contract, requiring him to accept all of the conditions, even those Z does not want to accept. A few security vulnerabilities have plagued smart contracts in recent years, resulting in both theft and financial losses. Formal analysis and verification of smart contracts before they were deployed on the blockchain could have prevented such vulnerabilities (Nzuva,2019, p.3). As an emerging technology, smart contracts currently face many challenges, such as legal, reliance on “off-chain” resources, immutability, scalability, and consensus mechanism issues because of country’s jurisdiction and formalities involved between two parties in the establishment of legal relations.

Predictions

Although blockchains have a technological advantage over banks and credit intermediaries, it is still too early to predict a complete disruption of the financial system with this technology. Therefore, a multi-centre weakly intermediated scenario is likely to be conceivable (Chang et al, 2016). In this case, banks use blockchain technology to improve their payment clearing systems and overcome certain obstacles in information communication and forming consortiums to consolidate their positions. This suggests that simultaneous clearing and transaction would also eliminate the need to reconcile in the future and makes banks more efficient in general. On the other hand, the decrease in the efficiency of each transaction would increase transaction security (Panisi, 2017, p.22). This is because that each new financial innovation has always been accompanied by an outbreak of debate concerning regulation, efficiency, and security. As a result, current obstacles may appear in the way of history, blockchain technology will eventually overcome its technical, regulatory, and other issues. Ethereum, Hyperledger Fabric, Corda, NEM, Stellar, and Waves are just some of the blockchain platforms available for deploying smart contacts with unique application features. It is therefore possible that smart contracts may be integrated into the banking industry in the near future.

Recommendations

Smart contracts can only be widely adopted if parties use a trusted technical expert to either record their agreement in code or verify that code written by a third party is correct. The analogy to hiring a lawyer to explain “legalese” is misplaced since there is no “legalese” in a traditional text-based contract. A non-lawyer can usually understand several provisions of a short form agreement as well as part of a long, complex agreement, especially those that outline business terms. Non-programmers, however, could not even begin to understand even a very basic smart contract. A chainlink oracle allows smart contracts running on any blockchain to communicate with any API (Application Programming Interface). In this case, they are significantly more dependent on an expert to explain the contract’s legal implications. In spite of the fact that this technology cannot completely eliminate intermediaries, it has already been proved that it will significantly simplify the economic turnover, and thus make modern business models more efficient, while at the same time reducing transaction costs.