The Future of Derivatives: An End-to-End, Legally Enforceable Option Contract Powered by Ethereum
OpenLaw and Rhombus have joined together to begin to automate standardized derivatives contracts. In this example we automated a standard call option contract based on the current price of ETH to Gold.
Open Finance: Automation of Derivatives
One of the visions of Ethereum is to build an open financial system, one that is more efficient, fair, and globally accessible. At OpenLaw, we’re committed to this vision and have a robust set of open source tools that enable any project or user to combine to automatically execute complex agreements tied to the real world.
A key cornerstone of an open financial system is the automation of derivatives. For those not steeped in finance, a derivative a financial instrument with a value that is reliant upon, or derived from, an underlying asset or group of assets — things like commodities, interest rates, or even stocks and bonds.
The market for derivatives is massive. For example, in 2017, the notional amount of outstanding derivatives contracts was approximately $542 trillion. Investors, market makers, and other financial players routinely enter into these contracts, in order to hedge risks or make a profit.
One of the most basic derivative contract is a standard call option. A call option contract gives the buyer the right to purchase an asset at a specific price — or strike price — over a specified period of time. These options can be traded over the counter (OTC) or through central clearing houses.
At OpenLaw, we’ve been fascinated with the derivatives marketplace and blockchains are rapidly maturing to the point where we can begin to automate the creation and execution of these agreements in a legally compliant and familiar way.
We’ve seen other attempts at executing options on a blockchain, but they fall short. The blockchain-based demonstrations move around assets, without using secure real time oracles and are often untethered from a real world agreement necessary to manage and account for unforeseen risks or misunderstandings.
Use Case: Call Option Contract
Today, with the help of Rhombus, we’re showing how OpenLaw has solved these issues. Rhombus is an oracle provider that offers multiple ways to securely deliver real world computational data into a smart contract.
Using our tools and the oracle services provided by Rhombus, we have the capability to streamline the creation, execution, and settlement of a derivative using blockchain technology and in a format that is compatible with the legacy world. Specifically, we automated a standard call option contract and integrated it with a custom Rhombus oracle based on the current price of ETH to Gold.
We mocked up a standard option contract using our domain specific markup language to enable anyone to automate the creation of the agreement in minutes. And, we worked with Rhombus to supply the current price of ETH to Gold.
Once Rhombus deployed its oracle contract, we wrote a smart contract that read this data and cryptographically tied it to the underlying agreement. Through their simple oracle interface, the entire project was brought together. To purchase the ether/gold call option, a user simply needs to view the ETH to Gold price, which triggered the creation of a standard option contract on OpenLaw.
Once generated, parties can execute the option in seconds. For example, if the oracle displays a current price of 10 ETH to Troy Ounce, the customer could generate an option contract whereby the option holder has the right to purchase 1 Troy Ounce for 11 ETH, 24 hours from the present time.
Once 24 hours passes, if the ETH/Gold price is more than 11 ETH, the user has the option — but not the obligation — to complete their purchase. If the user decides to exercise their option, 11 ETH is transacted and the user automatically receives a token representing one ounce of gold held in a vault.
In addition to having a smart contract token represent a Troy Ounce and automatically effectuate an exchange of assets, an OpenLaw user has the security of a traditional legal agreement that is enforceable in court. The OpenLaw legal agreement for a call option defines where and how the token may be redeemed for one Troy Ounce — as well as containing representations and warranties the actual gold is held in a vault.
The cross-section of legal documents, smart contracts, and oracles, as seen in this example, has the possibility to open up and provide a more transparent and accessible financial system — one that is cheaper, faster, and more efficient. Call options are just the beginning, soon a range of financial assets will be automatable with a click of a button. Once these tools are created, operational aspects of the financial world will be streamlined, reducing the role of lawyers, existing data providers, and potentially even financial institutions.
About OpenLaw & Rhombus
To learn more about OpenLaw, check out our site and documentation for an overview and detailed reference guide and. You can also find us at email@example.com or tune in in our community Slack channel. Follow our Medium and Twitter for further announcements, tutorials, and helpful tips over the upcoming weeks and months.
If you want to learn more about Rhombus and how they power secure, consistent, reliable, real-world oracles for smart contracts, learn more on their website, check out their technical docs, and contact them at firstname.lastname@example.org for a free consultation.
Disclaimer: The views expressed by the author above do not necessarily represent the views of Consensys AG. ConsenSys is a decentralized community with ConsenSys Media being a platform for members to freely express their diverse ideas and perspectives. To learn more about ConsenSys and Ethereum, please visit our website.
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