The author of this article, coming from Private Trust Partners, examines the terrain of smart contracts, including those much-talked about non-fungible tokens, or NFTs. These entities continue to stimulate talk in the wealth management industry.

The article comes from Private Trust Partners, part of TrustConsult, the Luxembourg-based group. Patrice Sauro, executive director, examines the world of “smart contracts” – one of the many digital assets that affect the world wealth managers inhabit. (We have looked at the broad impact that these technologies are having here.)

One internet definition of a “smart contract” is a “self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code” (source: Investopedia). Why do smart contracts matter, how do they work and how should private client advisors think about them? The author considers some of these questions. 

The editors at WealthBriefing are pleased to share these thoughts and invite readers’ reactions. As ever, the usual editorial disclaimers apply – jump into the conversation! Email tom.burroughes@wealthbriefing.com

Smart contracts are micro-apps that run on a blockchain. Ethereum is the most popular smart contract platform. These contracts allow you to lock up your money and then release it when certain conditions are met. We can implement many structuring products using this technique without the need for centralised authority. Smart contracts could handle things like automatic payments and investment products.

Smart contracts (also known as distributed apps) are becoming increasingly popular. They are basically treated in the same way as traditional contracts. The only distinction is that they are entirely digital. In reality, a smart contract is a small computer program that is stored within a blockchain.

Let's look at an example to see how smart contracts work. You've probably heard of Ulule, the popular fundraising platform. Product teams can use Ulule to create a project, set a funding goal, and begin collecting funds from others who believe in the idea.

Ulule is essentially a middleman between product teams and supporters (investors). This means that they must both trust Ulule to handle their money properly. If the project is successfully funded, the project team anticipates receiving funds from Ulule. 

Investors, on the other hand, want their money to go to the project if it was funded or to be refunded if it did not meet its objectives. Both the product team and its supports must trust Ulule.

However, using smart contracts, we can create a similar system that does not rely on a third party, such as Ulule. So, let's make a smart contract for it! We can program the smart contract to hold all funds received until a specific goal is met. The project's investors can now transfer funds to the smart contract. If the project is fully funded, the contract automatically transfers the funds to the project's promoter. And if the project falls short of its goal, the funds are automatically returned to the investors. That’s impressive.

Everything is completely distributed because smart contracts are stored on a blockchain. No one loses control of the money when using this method.

Why should we put our faith in a smart contract?
Because smart contracts are stored on a blockchain, they are endowed with some powerful properties. They are both immutable and distributed.

They are immutable: this means a smart contract can never be changed again after it is created. Also, being “distributed” means the output of your contract is validated by everyone on the network, so no one can go behind your back and tamper with the code of your contract.

As a result, a single person cannot force the contract to release the funds because other users on the network will notice and mark the attempt as invalid. Smart contract tampering becomes nearly impossible.

Smart contracts can be used for a variety of purposes other than crowdfunding. It could be used by banks to make loans or to offer automatic payments. It could be used by insurance companies to process certain claims. Postal companies, for example, could use it for payment on delivery.

At the moment, only a few blockchains support smart contracts, with Ethereum being the most popular. It was created and designed specifically to support smart contracts.

They can be programmed using the Solidity programming language. This language was designed specifically for Ethereum and has a syntax similar to Javascript. It's worth noting that bitcoin has smart contract support as well, though it's much more limited than Ethereum.

So, you're probably wondering where and how you can use smart contracts. NFTs are one application of smart contracts. Let’s see how NFTs work and what can they do.

NFTs in detail
NFT is an abbreviation for non-fungible token. Because something is non-fungible, it cannot be exchanged for another item. For example, one work of art is not the same as another. Both have distinct characteristics. Items that are fungible, on the other hand, can be exchanged for one another. One dollar or bitcoin, for example, is always equal to another.

What problem do NFTs solve?

NFTs are blockchain-based tokens that represent ownership of one-of-a-kind items. Tracking who owns a digital file has traditionally been difficult due to its ease of copying and distribution. So, how do you prove who owns the original file when everyone has an identical copy?

Well, NFTs do that. 

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Questions asked and answered
How do NFTs achieve this purpose?

Assume that you created a piece of digital art on your computer, essentially a JPG. This can be used to create or "mint" an NFT. The NFT that represents your art contains information about it, such as the file's unique fingerprint, a token name, and a symbol. This token is then stored on a blockchain, with you, the artist, as the owner.

Can I then sell it?

Yes, you can now sell that token by submitting a transaction to the blockchain. The blockchain ensures that this data is never tampered with. It also allows you to see who currently owns a token and how much it has been sold for in the past.

Aside from digital art, NFT's can also be used to sell concert tickets, domain names, rare in-game items, real estate, and basically anything that is unique and needs proof of ownership.

It is important to note that the artwork is not stored on the NFT or the blockchain. Only its attributes, such as the file's fingerprint (or hash), a token name, a symbol, and, optionally, a link to a web-hosted file, are stored.
 

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What if I buy one?

This is where an NFT becomes interesting. When you purchase an NFT that represents artwork, you do not receive a physical copy of the artwork. Most of the time, anyone can get a free copy. The NFT only represents ownership, which is recorded in a blockchain and cannot be tampered with. Some claim that NFTs provide digital bragging rights.

To add to the intrigue, while the token owner owns the original artwork, the creator of the NFT (the first original owner) may retain the copyright and reproduction rights (if that is stipulated in the smart contract). So, while an artist can sell his original artwork as an NFT, he can also sell prints. Again, that all depends on what’s included in the smart contract.

For example, Twitter's founder sold his first tweet as an NFT. Anyone can see that tweet on his profile, but it is now owned by only one person. And that person paid more than $2.9 million for it. This article could even be used to create an NFT. You could then purchase it and become the owner of the article, despite the fact that it is free to read for everyone.

Why are some NFTs worth millions?

Simply put, their value is determined by the amount of money people are willing to pay for them. If you're willing to pay a hundred dollars for an NFT, it's worth a hundred dollars. Prices are determined by demand, so be cautious because an expensive NFT loses value if no-one wants to buy it. If, on the other hand, you want to sell a pixel gorilla for €500,000 and someone is willing to buy it at that price, the transaction is considered perfect.

In summary, how do NFTs work?

NFTs are blockchain-based smart contracts. In this case, the contract records the item's unique properties as well as the current and previous owners. An NFT can even be programmed to pay royalties to the creator each time it is traded. At Private Trust Partners we can help you structure your NFT strategy and guide you through the steps along the digital path.

 

About the author

Patrice Sauro has held various positions in several countries in his career. From 1998 to 2003, he focused on corporate accounting, tax and treasury and served as European financial manager for the Dow Group. Subsequently, Patrice Sauro held a number of positions over 2004-2012 covering the EMEA area including developing geographies such as CIS and Gulf Coast Countries. From 2013 to 2019 he worked for Avantor Sciences out of its Californian headquarters, US. Upon his return to Europe, Patrice Sauro joined Trustconsult Group In Luxembourg where he is serving as CFO overlooking the group’s global operations, administration and finance in the various jurisdictions where it is active.

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VINCENT VAN GOGH: STARRY NIGHT. (n.d.). The Van Gogh Gallery.
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