A Smart-Contract to Resolve Multiple Equilibrium in Intermediated Trade

TL;DR

This paper develops a smart contract-based protocol to resolve multiple equilibria in intermediation trade, ensuring optimal trade volume and privacy through cryptography and zero-knowledge proofs.

Contribution

It introduces a novel smart contract mechanism that enforces equilibrium selection in repo trades while maintaining privacy and simplicity for real-world deployment.

Findings

The protocol selects the joint profit-maximizing feasible trade.

It prevents collapse to no trade by filtering hurdle-infeasible outcomes.

The smart contract operates with minimal strategic complexity for brokers.

Abstract

We construct an empirically founded model of a repo trade intermediated by two broker-dealers and prove multiple equilibrium and the existence of equilibrium at the joint profit maximizing volume of trade. We then present a smart contract that resolves multiple equilibrium by requiring each broker-dealer to report its client schedule and its minimum hurdle spread, and implementing a selection rule that filters out hurdle-infeasible outcomes. Whenever there exists an equilibrium that exceeds both hurdle spreads, the protocol selects the joint profit maximizing feasible trade and thereby avoids a collapse to no trade. The smart contract is a machine executed algorithm which eliminates the need for trust. Hardware and cryptography are used to prevent leakage of broker-dealer client trade schedules, and to enable privacy-protected auditing with zero-knowledge proofs of the integrity of computations. The outcome can be implemented by a myopic strategy where a broker-dealer truthfully reports its own variables without anticipating its counterparty's reports. This minimizes cognitive and computational complexity, thereby making our smart contract suitable for real-world deployment.