Fintech Payments

Smart contracts in regtech?

Smart contracts in regtech? Main image: Africa Studio,
Written by Faisal Khan

Faisal Khan on how the world can benefit from regulator initiated smart contracts on the blockchain.

Ask any licensed financial entity and they will tell you of the burden with respect to compliance that stems from regulation. It’s overwhelming, to say the least.

Financial regulators publish a series of laws (read: regulations) that have to be enacted on the entities that are being regulated. No matter what territory you decide to pick as an example: the US, Canada, a country in the EU, a developing country such as Pakistan or Peru, financial regulations are a nightmare to deal with. In most cases, regulations are legal logic committed to paper.

Like any other legal document, it starts with definitions and then the statutory law that defines it. A bunch of these define a particular regulatory framework. In most instances, the regulatory framework is kept up to date with notices, advisory, amendments, and so on. Just keeping track of these can be a nightmare, especially for new entrants to the field of regulatory compliance, where navigating through this seemingly never-ending maze of rules, sub-rules, footnotes, cross-references, advisory notices, alerts, amendments, and so on, can be mind-boggling.

At the end of the day, a regulation is a contract; a contract between the financial regulator and the licensee.

Smart contracts

While discussing smart contracts with some colleagues who are far more qualified than I in this field, I asked a question: What if a smart contract can be made out of these complex regulations? Possible? Yes! Probable? I don’t know. Too early to tell, but here’s how I would envision it. Granted, the thought process is extremely rough, but I’m penning it down nonetheless.

The blockchain has the ability to incorporate programmable assets. Most of the licensed entities are dealing with financial assets that can easily be incorporated onto a private blockchain. When logic is applied to these assets based on a certain rule set, they become smart contracts (see this slide from my blockchain presentation: What is Blockchain: History, Theory & Applications of Blockchain Explained):

Programmable Assets + Logic (if-then-else) equals Smart Contracts. Image by Faisal Khan.

If the assets of a company and the temporary assets it holds (think processing of payments or remittances, and so on) can be programmed onto the blockchain, what prevents us from programming the logic of the regulations onto the blockchain itself and presenting it as a smart contract? The answer is: Nothing! It’s very doable.

Do we program the entire regulatory framework?

No. Not everything needs to be programmed at first. That would take literally thousands, if not tens of thousands, of smart contracts, nested and cascaded. We don’t need to go that route … yet. Take a simpler approach – something that’s easy for the regulator to enact: renewal of a licence for a fee. This is perhaps one of the simplest cases to implement.

  • A licence holder can provide their bank account details (containing ACH) information.
  • The regulator defines the renewal date.
  • There is a section (flag) to check if there were any infractions/warnings given. If yes, then don’t renew, or if the infraction scoring was below say 250 (on a scale from 1 to 1,000)then renew, or else hold.
  • Come renewal time, the logic is checked and a decision is made one way or the other.
  • Emails can go out.
  • All the other regulators or associated entities that need to know about the renewal status can observe this from the blockchain.

Needless to say, this is a very simplistic approach towards a smart contract and quite frankly it doesn’t add much value. A communal database would also do this (such as the NMLS Database). More interesting uses cases can be towards reporting and filing, taxation, triggers for certain transactions, and so on. But the question that begs to be asked is how can the value-add of the blockchain be put to use?

Consensus for legal interpretation

As one of the core principles of the blockchain is consensus, it can be utilised towards the providing of an opinion on many aspects of the law. When a notification comes out, many-a-times a legal opinion is needed as to what the circular is saying. A smart (opinion) contract can be built on the blockchain, where every licence holder can contribute to a given set of interpretations and the consensus will let everyone know on the blockchain, that this is what it means. It may not be right, but at least you will know what the consensus is saying.

Bad actors (clients) can also go on to the blockchain to let the licence holders know of the possibility of fraud or criminal intent. Think of it as a licence-holder-based screening of customers. Individual contract points from the regulatory framework themselves can be converted to smart contracts. Examples could be the provisioning of a correspondent contract, a critical document to ensure the flow of money via legal (read: licensed) partners. The consensus on the blockchain can verify the validity of such a nodal contract between two entities.

Paid Up Capital can be measured via smart contracts, as can insurance (bond), which can be plugged into the blockchain as a smart contract, thus giving cover and acknowledgement that the transaction and the licensee is insured for it.

These are just examples to get the creative juices going. I’m sure that if one were to sit down and delve into the legal framework, one can find many more examples. It will be interesting to see how the space pans out.

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– This article is reproduced with kind permission. Some minor changes have been made to reflect BankNXT style considerations. Read more here. Main image: Africa Studio,

About the author

Faisal Khan

Faisal Khan specialises in cross-border money transfer and payment systems as a payments consultant and evangelist for digital money. He is a regular contributor to the Around the Coin podcast.

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