CrypTalk: Smart contracts could take the place of banks

In this episode of CrypTalk, BizNews’ Ross Sinclair speaks to Gaurav Nair of Jaltech, an alternative investment fund, about the Ethereum blockchain, smart contracts, its uses, and how new regulations being introduced will affect investors.

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Gaurav on the difference between Bitcoin and Ethereum

The major difference between Ethereum and Bitcoin is that Ethereum has the functionality to be able to execute smart contracts. And we compare this to the Bitcoin chain. The Bitcoin chain is so simple that really the only thing it can do is send Bitcoin from one person to another and keep track of all of those balances. However, the Ethereum blockchain has the ability to actually run programmes or lines of code, and these are often called smart contracts. And that is a self-executing contract. So, for example, you and I might get into a transaction and in the transaction, we might say I’m lending you $1,000 and on a certain event you pay me back those $1,000 with interest. And this is now put into lines of code and the various computers all around the world that run the Ethereum blockchain. If and when that event happens, those computers will automatically process the transaction and take the money out of your account and put it into my account, as we have agreed in lines of code.

On what smart contracts can do

So smart contracts are currently being used to build financial products and or replace financial institutions. And if we use the analogue of the Internet, this is almost the easiest application. So with the Internet, the first thing was email really, and this is the email to the Internet. And so, for example, you have smart contracts out there that have been built to do the work of a stock exchange or a foreign exchange broker. They take one token and allow you to exchange it for another. And these smart contracts, they have no human beings. Obviously, some human beings wrote the code initially and released it out there, but now it’s running on all these computers and the rules of the code are followed. And when you interact with a smart contract, you say, I want to put in token x I want to get out token y and it does it automatically without any human beings being involved. Another great example of a smart contract is one that replaces banks. So it does the primary work that banks do where you can deposit money and earn interest or you can take out a loan. And the way these smart contracts currently work is that you have to provide collateral to take out the loan and you’ve got to over collateralise. You have to provide more collateral than the loan you want to receive. These smart contracts have been running for a few years now, again, with no human beings involved, processing billions of dollars of transactions, and if there is a default event, selling the collateral.. And all of this is happening by automation, without any human beings intervening. And so one can only imagine the future of all the innovations that can be built on this. But there is one other very interesting thing about smart contracts, and that is that they are composable. So what composable means is a meme used in crypto: they call them money Legos and you can just plug them into each other. So you and I could come up with a new product today. We could say, Oh, we want a product where people put in an X and we then convert it to token Y and we earn interest in this way, and then we swapped their interest out, and we would just plug all these protocols together that already do this, all the smart contracts, and we could then create that without asking anyone for permission.  We could just create these products and make use of all of these money Legos.

On the regulations being introduced regarding cryptocurrencies

The regulations can be divided into two broad areas. The first area is being put together by a group called the IFWG/CAR. So big acronym salad there, but it’s the Inter-Governmental FinTech Working Group or the Crypto Asset Regulatory Working Group, and they are looking at the financial crime side of things. So guys that are financing terrorism and money laundering and that kind of thing, and how should we avoid or prevent those criminals from using crypto to achieve their aims? And this group has proposed various legislation and how to manage that. And the second part is exchange controls. And this group is also dealing with exchange controls. Then the other area of legislation is from an investment point of view, retirement funds, etc, so focusing on the first, the financial crime side, it looks very sensible. And these groups have been consulting with industry when it comes to the exchange control side. They proposed that cryptocurrencies be treated as foreign exchange, in essence. So what this means is that in the future, if people want to buy cryptocurrencies, they’d have to use the their foreign allowance. Everyone has a foreign allowance they can use every year. They’d have to do that.

And for companies – they won’t be allowed to buy cryptocurrencies because companies aren’t allowed to buy forex unless they have imports and exports: they can’t just speculate. So the liability of this approach is that as a country we might decide we want exchange controls and that’s a different discussion, whether they’re good or bad. If we want exchange controls, well, sure, we should prevent using crypto to abuse that. And if you don’t support exchange controls, then we need to get rid of those rules. Really. But the liability is that the tail is kind of wagging the dog here in order to protect exchange controls. The regulators are suggesting regulations that don’t really make sense for crypto, even though we call them cryptocurrencies, a lot of them aren’t currencies. A lot of these tokens represent other things. And in South Africa, we may see a future where two South African companies want to interact with each other using a smart contract. And if there are tokens involved, they want to send tokens to each other, which has nothing to do with offshore. But the way the regulations work, they wouldn’t be allowed. So on that, it really looks like we’re trying to fit a square peg into a round hole. We want to protect exchange controls, so let’s regulate cryptocurrencies as if they are exchange controls, as opposed to finding something that actually suits cryptocurrencies.

On Treasury’s legislation regarding retirement funds and Cryptocurrency

Recently, Treasury said that retirement funds are not allowed to invest into cryptocurrencies at all. 0%. There’s a bunch of other limits. They stipulate the maximum you can invest into equities and into bonds and so on, and there’s a category called “Other”. And retirement funds can invest two and a half percent of their funds into any investment. They say not even that. And so it’s a bit of a strange approach. The reason they put forward is that it’s too risky an asset. And we’ve seen this huge 50% drawdown recently. So it probably bears out that it is a risky asset. But the reason it’s strange is that it’s not often that they take this approach and say it’s forbidden. There are other risky assets out there from derivatives to other exotic assets, like rare art and precious coins and so on. And retirement funds can invest into all of these in the two and a half percent category. There are no restrictions. There’s a framework. There are trustees that are professionals and actuaries that all make these decisions. But Treasury has decided to take this decision away from them. Again, there’s a liability to this approach, which is that it deprives our investing professionals from developing the skills needed and it deprives our local economy from actually getting investments in crypto from these investors. They’re the biggest investors in the country. You know, even if you think crypto is a really bad idea and it’s going to go to zero, that’s really we really leave the decisions to investment professionals. We should leave them to decide whether these are good investments or not? And should they invest and how much? But in this case, Treasury’s taking that decision away, despite all these professionals and safeguards and guidance, so it’s a bit of a strange approach that Treasury has taken.

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