Multi-Trillion Dollar Derivative Market on Ethereum?

Multi-Trillion Dollar Derivative Market on Ethereum?

OpenLaw, a ConsenSys-backed blockchain project with a focus on legal compliance, has set its sights on transforming the multi-trillion dollar derivative market by bringing the contracts onto the Ethereum blockchain to be structured and executed. Using a brief video to showcase an Interest Rate Swap contract that has already been tested on the network, OpenLaw is demonstrating how these smart contracts can be used as an actionable and enforceable legal agreement.

Founded by software engineer David Roon and Aaron Wright, chair of the Enterprise Ethereum Alliance Legal Working Group, OpenLaw is intended to be a collaborative platform for lawyers to standardise contract templates and access legal technology tools.

Transparency to an Opaque Market

While a derivative is basically something that derives it’s value from the performance of an underlying asset, index or entity, the role derivatives play within the current global financial system cannot be overstated.

Although OpenLaw quote a figure of $12 trillion, this may just be intended to apply to the Interest Rate derivative market. The Bank for International Settlements (BIS) have published a higher valuation of that particular segment and other sources have suggested the entire value tied-up in the derivative market as a whole is anywhere between $533 trillion to $1.2 quadrillion, dwarfing all of the world’s bond and stock markets.

One of the reasons there is such a wide spread between the figures is no-one has yet published accurate data to reflect the multiple layers of derivatives in circulation. It is an opaque market that is perhaps best portrayed by a scene in the movie of the 2008 global financial crisis, the Big Short.

By stepping into the derivative arena, OpenLaw have signalled an intention to tackle an issue that has troubled analysts for years.

In 2003, billionaire investor Warren Buffet was so concerned about the complexity of derivative financial products and the “daisy chain risk” they posed, that he described them as “…financial weapons of mass destruction that posed a grave risk to the stability of the banking system.”

If the market turns against the bank holding the derivative, the consequences, as seen in 2008, can be fatal for that institution and, as Buffet indicated through his “daisy chain risk” analogy, possibly even for the entities who are on the opposite end of the derivative trade.

Mainstream media outlets, such as Reuters, have made the case that derivatives at banking institutions such as Deutsche Bank are a major present concern and led the Financial Times to ponder whether “Derivatives to crash markets again?”

It is too early in the platform’s development to suggest OpenLaw could even partially rectify the problems facing the existing derivative system, but any new contracts structured on the Ethereum blockchain would certainly provide a level of transparency that has been absent up to now.