Various forms of algorithm contracts

Oct 05, 2021 By Si Gyeongmin

In practice, there are many forms of algorithmic contracts, such as high-frequency trading, dynamic pricing, and Ethereum's "smart contracts".

First, High-Frequency Trading (HFT)

High-frequency trading is computerized trading of financial products using proprietary algorithms, including Execution Trading and Small Opportunity Trading. High-frequency trading brings many market efficiency and fairness issues. High-frequency trading can only be carried out under complex and specialized algorithms, otherwise, it will be regarded as illegal transactions, but the use of specialized algorithms to hide illegal purposes is not ruled out. One of the main purposes of high-frequency trading is to conceal market information in order to profit from the other party with asymmetric information.

Algorithmic trading reduces the information distribution function of the financial market, and the "flash crash" is only an extreme manifestation of a common phenomenon. High-frequency trading involves "black box" algorithmic contracts and "transparent box" algorithmic contracts. At this time, the algorithm acts as an investor's agent, determines and executes the best way to achieve the overall profit goal, while covering its calculation process. Therefore, the counterparty can only see the price offer and cannot know the specific procedure of the algorithm. High-frequency trading has caused huge losses, but in practice, there are still no legal precedents related to contract law and high-frequency trading.

Secondly, Dynamic Pricing.

Dynamic pricing uses information about the market, product, and buyer to set the price to the highest price that the buyer is willing to pay. The most classic form of dynamic pricing is airline ticket quotations, which customize price terms for buyers based on personal information, departure time, distance, and airline prices. The price discrimination of dynamic pricing is usually concerned, and the policy of algorithmic contracts is also reflected here.

Finally, Ethereum and "Smart Contracts".

Compared with high-frequency trading and dynamic pricing, smart contracts can better expose the limitations of current contract law in algorithmic contracts. Smart contracts eliminate the need for trust between parties. Smart contracts can be self-fulfilling, and the contract is the code. The contract is defined by the code and is automatically fulfilled by the defined code. There is no human intervention for participation and decision-making.

The difference between smart contracts and other forms of algorithm contracts is that Ethereum has the ability to create so-called "decentralized autonomous organizations" (DAOs). DAOs operate according to the rules and regulations clearly explained in the interrelated software code rather than the agreement charter. DAOs operate completely in a programmed manner, and there is no opportunity for third-party interference or fraud. However, the contract concluded by DAOs may not be fulfilled because the investors of DAOs intend to be very different from the contracting behavior of DAOs.

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