Jørgen Svennevik Notland

Corruption is a major global financial problem with billions of dollars rendered lost or unaccountable annually. Corruption through contract fraud is often conducted by withholding and/or altering financial information. When such scandals are investigated by authorities, financial and legal documents are usually altered to conceal the paper trail. Smart contracts have emerged in recent years and appear promising for applications such as legal contracts where transparency is critical and of public interest. Transparency and auditability are inherent because smart contracts execute operations on the blockchain, a distributed public ledger. In this paper, we propose the Minimum Hybrid Contract (MHC), with the aim of introducing 1) auditability, 2) transparency, and 3) immutabil-ity to the contract's financial transactions. The MHC comprises an online smart contract and an o✏ine traditional legal contract. where the two are immutably linked. Secure peer-to-peer financial transactions, transparency, and cost accounting are automated by the smart contract, and legal issues or disputes are carried out by civil courts. The reliance on established legal processes facilitates an appropriate adoption of smart contracts in traditional contracts .

Having identified contracts as the nexus of corruption, I sought to find how contracts, blockchain smart contracts, and financial regulations can be used to make them both secure, accountable, transparent, and inclusive. Then I explored how corruption in a contractual relationship could be mitigated, using the term Minimum Hybrid Contract (MHC) which I coined, where a smart contract is a supplement to a legal contract providing transparency and immutability to the contract’s financial transactions, privacy is accepted as a human need and total transparency must be avoided.

The extensive literature review on blockchain explains its key features for financial transaction; transparency and immutability. Blockchain smart contracts can interplay with, or replace legal contract, and mitigate agency theory issues which increases trust in the principal-agent relationship. The MHC is an evolutionary change proposition to ensure stability because it leaves the legal contract as it provides a smart contract as a supplemental transactional tool.

To implement the MHC architecture in a legislation cryptocurrencies are required for the blockchain smart contract to work. Because there is regulatory uncertainty around cryptocurrencies whereas they are illegal in several countries, regulatory strategies such as sandboxes and safe harbors giving regulatory slack and closer collaboration with innovators to ensure financial stability while searching for the optimal regulation is an elaboration on the design of the MHC.

Key agency theory issues are be mitigated significantly when blockchain smart contract’s transparent, open, and immutable properties are leveraged in financial transactions. Information sharing increases when using blockchain because a receipt for a financial transactions is indistinguishable from the transaction itself, thus the MHC provides a deterrent against financial crime by removing the opportunity of conducting receipt fraud. Moreover, the MHC mitigates moral hazard because auditing the immutable and transparent blockchain-based transactions does not require trust in the auditor because the process can be automated by automatically reading data from the blockchain smart contract. Thus agency costs are also reduced as the monitoring costs of financial transactions are reduced, and blockchain smart contracts replace auditors.

The blockchain is a new groundbreaking open-source technology (Nakamoto 2008) which was initially released as the underlying technology for the world’s first decentralized global digital currency, Bitcoin. The blockchain is an immutable and transparent distributed database, a ledger which has global consensus by all participants. This means that the things written in the ledger can’t be edited and cheated, thus trusted if the writer is trusted.

The supply chains for commercial markets are opaque and complex, they can span over hundreds of production stages and several geographical locations so that the provenance and history of a product is usually unknown to upstream actors. Lack of transparency and trust in the supply chain lead to lack of information about the provenance and working conditions behind the product. There has been shown that some actors behave illegally and unethically.

This thesis’ research purpose is to investigate the nature of trust in supply chains and if blockchain technologies can increase trust in supply chains. A theoretical framework involving trust and transparency in supply chains, blockchain and record keeping has been established.

Blockchain has its strengths and limitations: high integrity but unstable information reliability. How data is recorded on the blockchain is considered critical and require a trusted third party recording transactions to guarantee information reliability. The authors believes that if the problem of information reliability is solved, trust in blockchain implementations will increase.

The actors in the supply chain need an incentive and clear profit in order to have any motivation to implement the blockchain technology. A strong incentive and a method and specific steps for implementation still remains to be researched.