Casper leads the initiative in setting open-source smart financial contract standards, particularly through the adoption of the ACTUS Standard, which is crucial for providing a consistent data model and algorithmic definitions across financial contracts. The implementation of ACTUS is a top priority for Casper to establish a unified standard for the tokenization of assets, paving the way for seamless integration and interoperability in finance and the digital asset ecosystem.
The annual ACTUS Conference will take place in Washington DC on May 15, 2024. Be sure to save a virtual seat by registering here or attend in person by registering here.
As we approach the conference date, Allen Mendelowitz, the President of the ACTUS Financial Research Foundation, answered our questions regarding the role and potential of ACTUS Standard in finance, its implementation, and more.
Q.1: How does the implementation of the ACTUS Standard on Casper redefine financial applications on blockchain?
Allan Mendelowitz: Currently, financial contracts typically define the exchange of contractual payment obligations with natural language. Nevertheless, these payment exchange agreements follow well-understood algorithms. Such algorithms use a mathematical implementation of the business logic of a contract and the contract terms that appear in the contract to compute the timing and amounts of payments required by the contract.
When a financial contract is put on the balance sheet of a bank, it is implemented as an algorithm so that it can be effectively administered using the bank’s computer systems. For example, a simple bond is defined by the contract’s terms (which include issue and maturity dates, an interest payment cycle, and an interest rate). These data, combined with the appropriate algorithm, are what compute the payments or cash-flows required by the contract.
The ACTUS Standard provides a tested and validated set of algorithms and a carefully defined dictionary of contract terms that together generate the payment obligations of almost all financial contracts extant in the market.
Q.2: What does the ACTUS Standard bring to the tokenization of a bond or other financial contracts?
Allan Mendelowitz: Tokens define the ownership of the financial contract, whether fractional or a single person or entity. In the simplest case the token points to a hash of the PDF of the contract written in natural language by lawyers. Since the future cash flow required by the contract is of the greatest interest, to figure out what it is, we must find the document, read it, and calculate the future payments from the data in the contract.
This can be an exercise of hours and even days. Because ACTUS defines both the contract terms and the associated algorithms needed to calculate the future cash flows, it offers a more reliable and efficient way to compute the contractual payment obligations. By defining a contract in the ACTUS Standard, which accurately calculates cash flow obligations and is freely available to everyone, the efficiency and reliability of the use of tokenization can be dramatically enhanced. With a hash that points to a contract in which the payment obligations are represented in the ACTUS Standard, anyone can calculate the future cash flow with absolute certainty and understand the obligation from all financial and risk perspectives.
Q.3: Can you elaborate on how the ACTUS Standard facilitates interoperability among financial assets across different blockchains?
Allan Mendelowitz: Today, interoperability is a huge problem since all parties refer to the paper document just mentioned, and everybody must compute the payment obligations by themselves. If the ACTUS Standard is used in the contract, the algorithms needed to compute payment obligations are clear, available, and executable by everyone. In such a case, everyone will arrive at the same contractual payment numbers. What can take hours or days with reference to a natural language contract can take only minutes or even seconds when the ACTUS Standard is used.
Q.4: How do tokenizing financial instruments using ACTUS on Casper improve efficiency, transparency, and security in capital markets?
Allan Mendelowitz: Efficiency will increase as described in our answer to the previous question. Transparency will increase because ACTUS demystifies finance and makes it easy for anyone to understand what the exact payment obligations of any contract are, no matter how complex they might appear to be.
The open-source nature of the ACTUS Standard means that anyone can have free access use it. This access will increase the transparency and common understanding of complex financial instruments. The clear definition of the financial agreement “ab initio” in the ACTUS Standard reduces the likelihood of counterparties entering into opaque and poorly understood contracts. The use of the blockchain increases security regarding the ownership and agreed terms.
Q.5: With the adoption of ACTUS, what future developments can we expect in DeFi and traditional finance?
Allan Mendelowitz: Everything about finance can be improved dramatically. Banks can operate much more efficiently. Clients of banks will be able to better understand the obligations they are taking on.
Even regulation will improve. Regulators who currently rely heavily on the analysis of static, backward-looking data can use forward-looking analysis made possible when a bank’s balance sheet is represented in the ACTUS Standard. To use the analogy used by Sen Dodd, the goal is to enable regulators to drive the car looking through the windshield rather than the rear-view mirror. This is what ACTUS makes possible.
Q.6: How do smart financial contracts based on ACTUS enhance the current tokenized assets and what impact do they have on the broader digital economy?
Allan Mendelowitz: I think the bulk of the answer was given in the answer to the first question. Expanding on those points, finance compared to all other industries, has not fully entered the digital world. This answer might be surprising given the fact that banking was among the first – if not the first – industry to embrace the use of computers.
Some functions, such as payment systems, have been transformed by computers and networking technologies. Nevertheless, much of the promise of computers to transform business processes has not been realized. When banks started to use computers they simply ported paper processes to the first computers. They could work with larger data sets, and slice and dice them in more ways, yet many business processes did not change. ACTUS, by defining the core business of finance with a validated algorithmic standard, provides the basis for trustworthy smart financial contracts. This will enhance finance as such. DLT and tokenization can take it even further.
Q.7: What are the main challenges in standardizing financial contracts on blockchain, and how is ACTUS addressing these challenges?
Allan Mendelowitz: The major challenges for DLTs are bringing the functionality of finance to the blockchain, doing it efficiently, and being able to scale to a level currently provided by legacy financial institutions.
Smart Financial Contracts provide the functionality of finance. Building these smart financial contracts around the ACTUS Standard means that the potential for errors in smart contracts is reduced. That in turn raises the confidence of counterparties that they understand the obligations they are entering into and that they are less likely to encounter after-the-fact surprises.
Taking advantage of what the ACTUS Standard can do is much easier for the DeFi world than the existing legacy financial institutions. People involved in DLT technologies start with a clean sheet of paper when deciding how to do things. They are not operating with critical legacy systems that have been around for many decades.
Adopting innovations is much easier in the absence of such legacy systems. The existing banks will take substantially more time to take advantage of the ACTUS Standard. The challenge for legacy banks to take advantage of the ACTUS Standard is their dependence on critical legacy systems that cannot be replaced easily without disrupting day-to-day business operations.
This situation gives the blockchain community an opening: if it can provide the functionality of finance, do it more efficiently than existing banks, and scale to a level of operations required by the size of the financial markets, it can be a disruptive force in the financial world.
Q.8: How does the ACTUS framework ensure compliance with regulatory requirements in the financial industry, particularly in tokenization and digital securities?
Allan Mendelowitz: The current regulatory framework for blockchain and tokenization is very fluid. However, certain considerations are consistently the focus of regulation: safety and soundness, financial stability, consumer protection, equal treatment, etc.
Tokenization that is deployed with the ACTUS Standard to calculate payment obligations supports these regulatory objectives. ACTUS contributes to transparency in financial markets, it reduces the ability of lenders to take advantage of clients with opaque financial instruments, and it makes clear exactly who owes whom what and when in a way that makes clear the extent of interconnectedness in financial markets and the potential for cascading failures.
Q.9: Can the implementation of ACTUS on Casper influence the adoption of blockchain technology in traditional financial sectors?
Allan Mendelowitz: Permissioned blockchains are being used in a whole host of applications in the real economy. The use of blockchains for finance (as distinct from simple payment systems) has lagged the uptake of these other applications. With the deployment of tokenization and smart financial contracts using ACTUS to define contractual obligations, blockchain can move into the financial world. If it is done well and efficiently, it can succeed. When that happens, traditional financial institutions will take notice and will respond. One way of responding is to use the blockchains in the course of their ongoing businesses.
Q.10: What new opportunities and innovations does the ACTUS Standard unlock for Casper developers and users?
Allan Mendelowitz: The challenge is to build systems that provide the real functionality of finance. The value of ACTUS in this context is that it brings real finance to the DeFi/DLT world. This in turn will create opportunities for DeFi/DLT to enter financial markets and secure a portion of the business.
Q.11: Looking ahead, what are the next steps for ACTUS to further disrupt the financial sector?
Allan Mendelowitz: We currently see the adoption of ACTUS at several important institutions. DTCC is now building on the use of ACTUS as it develops the capacity to automate clearing and settlement that will enable t+0. We see the same movement (in a more nascent state) at CCDC, the Chinese equivalent of DTCC. Imagine, these two giants build on ACTUS. They sit at the source, there where the real contracts are algorithmically defined. If contracts are defined at the source on ACTUS, then the game is clear.
ACTUS is already a liaison-A member of ISO TC68. Hopefully, we can do the paperwork this year and make ACTUS THE algorithmic ISO standard. There are movements at the regulatory level. More about this later.
Q.12: What innovations in financial management can attendees expect to learn about at the ACTUS Conference 2024?
Allan Mendelowitz: At this conference, we will focus on examples of how ACTUS is being used in the real world, including its use at DTCC to support moving to t+0 clearing and settlement, its role in bringing real finance to the DeFi/DLT world, its role in a prototype system to for monitoring systemic risk, and its role in a risk model for use by banks to analyze the full range of risks faced by a bank and a pension fund.
