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  • The Promise of Smart Contracts

    Posted on by Azrael Comment

                         STAN
    Jerry, we’re not just going to
    give you seven hundred and fifty
    thousand dollars.

    WADE
    What the heck were you thinkin’?
    Heck, if I’m only gettin’ bank
    interest, I’d look for complete
    security. Heck, FDIC. I don’t
    see nothin’ like that here.

    JERRY
    Yah, but I — okay, I would, I’d
    guarantee ya your money back.

    WADE
    I’m not talkin’ about your damn
    word, Jerry.

    Fargo (1996)

    Fargo is primarily a movie about promises, implicit and explicit. It asks whether we will keep our promises to others, even against our own self-interest. What makes the movie fascinating is that many of the promises aren’t backed by the court system, for very good reason — the deals are illegal. Fargo asks if we can trust each other even if there is no government force making us comply. In other words, can we make contracts in the state of nature? In 1651, Hobbes argued that we couldn’t:

    “If a covenant be made wherein neither of the parties perform presently, but trust one another, in the condition of mere nature (which is a condition of war of every man against every man) upon any reasonable suspicion, it is void: but if there be a common power set over them both, with right and force sufficient to compel performance, it is not void. For he that performeth first has no assurance the other will perform after, because the bonds of words are too weak to bridle men’s ambition, avarice, anger, and other passions, without the fear of some coercive power…”

    In other words, we need some external mechanism to enforce our promises, to make it so that other people can depend on our commitment. Making credible commitments is the foundation of business and society in general. Like Hobbes, we tend to assume that the government’s coercive power is the only way to create contracts. Nobel Prize-winning economist Oliver Williamson called this view legal centralism, the assumption that “the legal system enforces promises in a knowledgeable, sophisticated, and low-cost way” (Williamson, 1996, 121).

    Williamson and other Nobel laureates, such as Elinor Ostrom, built their careers on proving this assumption wrong. In many instances, the court system is costly and time-consuming, and sometimes corrupt. Moreover, people are often surprisingly able to enforce promises and maintain order in their own communities without government.

    Promises, Promises

     

    Trust is the bedrock of society. Without it, life would look a lot like Hobbes’ state of nature — constant suspicion, backstabbing, and insecurity. A person might make a promise, but given the opportunity, they might break it and pursue their own self-interest, a scenario which Williamson calls opportunism. However, business deals depend on being able to trust that a promise will be kept, otherwise our society would be limited to instantaneous exchanges. Fortunately, there are a number of mechanisms that can be used to secure a promise, all of which have advantages and disadvantages [1].

    For instance, we might depend on personal ethics and only make promises with people who have a strict moral code. The advantage of relying on personal ethics is that they don’t require institutions or outside coercion, but ethics also have a severe limitation: it’s difficult to know very many people well enough to trust them to do the right thing, and even the best people might break their promises.

    Another enforcement mechanism is reputation. Before making a contract with someone, we can ask around and find out how their previous interactions went. Reputation is extremely useful in small communities with repeated transactions since, if someone breaks their promise, they will be labeled untrustworthy and will be excluded from future interactions. However, reputation is more difficult to apply when interacting with strangers.

    Other enforcement mechanisms for promises include strategies like vertical integration in business (where opportunism is curbed through the alignment of incentives) and the use of collateral.

    The Internet Problem

    But the Internet, currently a state of nature if there ever was one, presents new difficulties. Personal ethics, of course, are always helpful, but there is no guarantee that a random stranger will be ethical. Reputation is more difficult because pseudonyms like email addresses and usernames are often used instead of true names. When a person breaks their promise, they can simply erase their history by creating a new pseudonym with a clean reputation.

    Being able to cheaply create a new pseudonym in order to dodge a bad reputation is called whitewashing (Nisan 2007, 682). There are various ways to handle the problem of whitewashing. One is to distrust all newcomers since they could have a new identity to hide a bad reputation. Another possibility is to ensure that any pseudonym is tied to a real person or business so that a bad reputation can’t be escaped.

    So why don’t we just create a global reputation system connected to our real-life identities? China is doing just that. As Wired explains, people with low ratings (including those who speak out against the government) will be punished in nearly every aspect of their lives: slower internet speeds, restricted access to restaurants, and the removal of the right to travel. They will have extreme difficulty being hired, renting apartments, and getting loans. In other words, a global reputation system can become less about trustworthiness and more about allegiance to authority.

    It’s clear that many of the enforcement mechanisms are hard to apply to the Internet. Personal ethics are ideal but unreliable. Reputation systems that attempt to enforce societal or organizational norms must be carefully designed lest they turn into “basically a big data gamified version of the Communist Party’s surveillance methods” (Botsman 2017).

    Lastly, laws cannot be easily applied to people in different countries, since each geographic jurisdiction has its own separate legal system, and there’s little chance of forcing a person from the Internet (especially if they are anonymous) to appear in court in a different country.

    A Tool Is Only Good if It’s Useful

     

    It is important to realize that all of our enforcement mechanisms are merely tools to be used when helpful. Like a hammer or a screwdriver, each tool might apply in a different situation. Moreover, like tools, our enforcement mechanisms are subject to innovation. For hundreds of years, since Hobbes, we’ve tended to think of contracts as legal agreements that must be enforced by the court system. However, court enforcement is only one of many ways to enforce promises, and we need to hold open the possibility that we can improve on it.

    As public choice economist Gordon Tullock pointed out, “We tend to forget that there is such a thing as technological progress in contracts. People discover new ways of making agreements, and over a period of time we obtain considerable benefit from this sort of technological progress” (Tullock 1970).

    One such example of technological progress is the invention of smart contracts. Smart contracts are a new mechanism for enforcing promises, allowing us to make credible commitments with each other on a blockchain, including commitments with strangers in other countries. To be clear, smart contracts are not legally enforceable, but that’s part of their unique advantage. Smart contract commitments are enforced outside of the law, outside of legal jurisdictions, without government enforcement.

    Given that our legal jurisdictions are primarily tied to our geographic location, and many countries have frail or unreliable legal institutions, this is a huge societal advance. It means that given an Internet connection, someone from one of the poorest countries in the world can make business deals and credible commitments with someone in the US as easily as if they were American. By creating trust where there was none, the world will be opened like never before.

    Smart Contracts

    The idea of smart contracts originated in the mid-90s when programmer and legal scholar Nick Szabo published a series of articles explaining their potential [2]. Like a vending machine, smart contracts rely on machinery for enforcement. However, instead of using physical machinery, smart contracts are literally code that runs on a blockchain, a kind of open, distributed ledger that runs on the computers of thousands of users, and which has no central authority.

    Contrary to their name, smart contracts have nothing to do with artificial intelligence. “Smart” refers to their self-enforcing quality. Smart contracts are immutable, meaning that the code by default cannot be changed. For the purposes of the contract, this is a good thing, since it’s impossible to break a promise if you have no opportunity to do so.

    However, for programmers, immutability presents a special challenge. All code has bugs, and code that cannot be altered needs to be written carefully to try to minimize the number of mistakes since the bugs can’t be fixed after the fact. Thus, writing a smart contract is like trying to write code for NASA — correctness matters a great deal, and the consequences of bad code can be dire.

     

    A smart contract might be as simple as a transfer of money from one account to another after a certain time, or it might be very complicated. However, one major limitation is that smart contracts can only transfer digital assets that are defined on a blockchain, such as cryptocurrencies. This might seem like a show-stopper given that cryptocurrencies aren’t yet widely accepted, but transferring money subject to certain conditions is all that many contracts do. Also, even contracts that include actions with physical objects can potentially be enforced by putting up bonds that will be lost if the promise isn’t kept.

    Another limitation is that smart contracts cannot access outside information unless it is written to the blockchain. For instance, a smart contract by itself has no access to weather data. To condition a contract on the temperature, for example, there must be a third party that takes the data from a weather API and writes it to the blockchain in a way that is accessible to other users. This trusted data source is called an oracle.

    There Are Advantages and Drawbacks

    Smart contracts have many limitations. However, we tend to forget that the courts have limitations as well. We shouldn’t compare smart contracts to an idealized version of court-enforced contracts. When we view both critically, it becomes clear that court-enforced contracts have intrinsic flaws. First, access to the court system is rationed, and there are many people waiting for their turn simply to use the service. This means that cases may take years or even decades. Because of the slowness of the courts, businesses often use private arbitration clauses in their contracts that allow them to settle out of court.

    Another often-overlooked limitation of the court system is that because the court is an external third party, it can only guess at the true damages if the contract is breached. This is problematic because the court system determines what will be given to the aggrieved party.

    Unfortunately, simply asking the aggrieved party how much the performance of the contract was worth to them isn’t going to work — they have no incentive to be honest in reporting their damages. Therefore, the court system tries to use its best judgment to determine what the damages are, but as Georgetown Law professor Randy Barnett points out, “Any assessment of legal damages attempts to quantity or objectify that which is actually subjective and essentially unmeasurable…” (Barnett 2010).

    The solution is for the parties to write their valuations explicitly in the contract, as liquidated damages. However, the courts may decide not to enforce these if they think they are unfair. Thus, even in countries with the best institutions, court-enforced contracts have intrinsic limitations and paternalistic aims.

    Smart contracts are not legal contracts, and in many cases may not be a good replacement for legal contracts. However, they are a valuable new tool in our limited toolbox. They allow us to make commitments — even with strangers — without government enforcement, something many, for hundreds of years, have assumed was impossible. In the next few decades, smart contracts will give people around the world the power to make agreements with each other despite corrupt and broken institutions, and so transform the lives of millions.

    Footnotes

    1. In Order Without Law: How Neighbors Settle Disputes (Ellickson 1991), Yale Law Professor Robert C. Ellickson studied how cattle ranchers in rural Shasta County, California enforced their promises, and categorizes some of the constraints on behavior thusly: personal ethics, contracts, norms, organization rules, and law. Anthony T. Kronman, also a Yale Law Professor, wrote about the ability to make contracts without using court enforcement in Contract Law and the State of Nature (Kronman 1985). He describes a number of devices, such as “hostages,” collateral, hand-tying, and the alignment of incentives by union.
    2. One of the primary pieces is Formalizing and Securing Relationships on Public Networks (Szabo 1997).

    Works Cited

    1. Barnett, Randy E. The Oxford Introductions to U.S. Law: Contracts. Oxford: Oxford University Press, 2010.
    2. Botsman, Rachel. “Big data meets Big Brother as China moves to rate its citizens.” WIRED. November 28, 2017. Accessed February 05, 2018.
    3. Ellickson, Robert C. Order Without Law: How Neighbors Settle Disputes. Cambridge, MA: Harvard University Press, 1991.
    4. Hobbes, Thomas, and J. C. A. Gaskin. Leviathan. Oxford: Oxford University Press, 1998.
    5. Kronman, Anthony T. “Contract Law and the State of Nature.” Journal of Law, Economics, & Organization 1, no. 1 (1985): 5-32.
    6. Nisan, Noam, Tim Roughgarden, Éva Tardos, Vijay V. Vazirani, and Christos H. Papadimitriou. Algorithmic Game Theory. New York: Cambridge University Press, 2008.
    7. Szabo, Nick. “Formalizing and Securing Relationships on Public Networks.” First Monday. September 1, 1997. Accessed February 05, 2018.
    8. Tullock, Gordon. Private Wants, Public Means: An economic analysis of the desirable scope of government. New York: Basic Books, Inc, 1970.
    9. Williamson, Oliver E. The Mechanisms of Governance. New York: Oxford Univ. Press, 1996.

    Reprinted from Libertarianism.org.

    Kate Sills


    Kate Sills

    Kate Sills holds degrees in Computer Science and Cognitive Science from UC Berkeley.

    This article was originally published on FEE.org. Read the original article.




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  • What Really Matters about Bitcoin

    Posted on by Azrael Comment

    After Bitcoin hit $10,000, it, at last, seemed to dawn on the mainstream financial press that this thing matters. There has been a panic rush to catch up on the meaning of it all. Some have doubled down on the claim that the whole thing is a hoax. Others dismiss it as a bubble (indeed, all financial models would suggest that a correction is needed). Some bigshots have called for it to be banned as if it is even possible to ban a mathematical protocol.

    So much confusion out there! Having followed this technology from 2010, here are the ten points I find most salient about Bitcoin and the entire cryptoasset sector.

    1. It was not invented by government. From the ancient world, it has been claimed that money (right and proper money) is the domain of government, at the very least to guard but also to invent, impose, and manage. In the late 19th century, an entire school of economic thought grew up around it: the State Theory of Money. Georg Friedrich Knapp’s treatise by that name came out in 1905 (English translation 1924) and helped entrench the nationalization of money in central banks. Bitcoin shows that the theory is wrong. Good money emerges from exchange and entrepreneurship, as Carl Menger said.

    2. It was not invented by academia. The Bitcoin protocol was released by an anonymous programmer on a small email list and then put into the commons. Economists – to say nothing of political scientists and sociologists – were entirely out of the loop. This is fascinating because mainstream intellectual hierarchy puts academia at the top and everyone else underneath. The black robes rule the course of history and everyone else is their benefactor, it is said, as if there were a structure of production for ideas. The problem with this theory emerged in the age of capitalism, when the practitioners, not the theorists, starting getting all the good ideas. Then the backlash came in the 20th century: the experts would manage society. Now we are finding out something amazing: the best ideas come from those with boots on the ground.

    3. It’s not all about Bitcoin. In some ways, the high-flying returns on the headline cryptocurrency are a distraction from the genius of the underlying technology: the distributed ledger called the Blockchain. This technology has spawned a financial sector just as large as Bitcoin itself, with thousands of applications, including every form of contracting. Blockchain could even lead to an upheaval in the relationship between the individual and the state. The critical thing to understand about the technology is this: it is a better way than we’ve ever had to document and enforce ownership claims. If you do not understand what this sentence means, I’m sorry but you do not understand the value of this technology.

    4. The old regulations won’t work. This technology is completely new, whereas all existing financial and regulatory machinery is based on muscling legacy technology to perform in a certain way. Retooling the regulations to fit simply won’t work. It is only going to create messes, slowing down but not stopping, progress. Legacy bureaucracies and stakeholders will fight and fight but nothing can stop this revolution, which is borderless and digital, making it impossible to control. Moreover, every regulation reduces competitiveness and entrenches incumbent firms. Do you think if government had banned, for example, horseshoes, electricity, internal combustion, or flight that this would have actually stopped these ideas from becoming reality? Governments are an annoyance, not the authors of history.

    5. Money will be competitive. Many people see the current goings-on as a struggle between the dollar and Bitcoin. That is too simplified. The real struggle is between national money monopolies and a newly competitive system. That competition occurs between cryptocurrencies and cryptoassets. People want to know who the winner will be. This too is old-world thinking. The competitive process will never stop. Winning will be temporary, and a new challenger will rise up and take the top spot. This is a new world. No living person knows what this is like because money has been protected from market pressure for so long. In particular, Americans are going to have to get used to a world in which the dollar is no longer king.

    6. Banking and credit will change. The whole institution of central banking is premised on the idea of a money monopoly which thereby enables full control and macroeconomic management. Crypto doesn’t have to be number one in order to wreck this presumption. It only needs to bust the monopoly. With a market cap of half a trillion dollars, this might have already happened. Moreover, distributed networks weave together money and payment systems, so old-world payment processors will be next to fall. New players are crawling out of the woodwork by the day.

    7. The unbanked have rights. Some people estimate that the unbanked of the world population is two billion. That is surely an underestimate. Think of the developing world but don’t limit it to that. Where I live, the unbanked are everywhere, and they are that way for a variety of reasons. Maybe they fear the privacy intrusions. They have lifestyles and sources of income that fall out of the mainstream. They might have sketchy professions. Or they are too young. Maybe it is a family issue or they fear getting roped into the system. Whatever the case, they still retain economic rights, and Blockchain tech gives them options for the first time. This is the population that will fuel the entrepreneurship in this sector.

    8. No one will be in charge. Blockchain has no central point of failure and no overarching controlling force. Financial intermediaries are not out of the picture but they are not essential. The systems of the past evolved into cartels; the systems of the future will be increasingly decentralized with non-stop disintermediation. Anyone who seeks full control will wake every day to the reality of shattered illusions. This goes for huge financial firms and also governments. Traditional policy rationale is rooted in the presumption of the preeminence of a single vision. The decentralized future will be rooted in the reality of nonstop disruption. No ideology can stop this.

    9. It’s a template for everything. Bitcoin isn’t really about Bitcoin. It’s about human liberty. We are not happy to live in cages of anyone’s construction. The goal of human life is to find a way to freedom. Governments and their lackeys laughed and dismissed this whole revolution, circa 2009 to 2017. There is no way the bird can escape, they said. Now it is too late.

    10. No one knows the future. No one could have anticipated this would happen. No one can know what lies in store for us. The future will be crowdsourced. This seeming chaos will find itself toward orderliness, and massively improve life on earth. That is how it should be.


    Jeffrey A. Tucker

    Jeffrey Tucker is Director of Content for the Foundation for Economic Education. He is founder of Liberty.me, Distinguished Honorary Member of Mises Brazil, economics adviser to FreeSociety.com, research fellow at the Acton Institute, policy adviser of the Heartland Institute, founder of the CryptoCurrency Conference, member of the editorial board of the Molinari Review, an advisor to the blockchain application builder Factom, and author of five books, most recently Right-Wing Collectivism: The Other Threat to Liberty, with a preface by Deirdre McCloskey (FEE 2017). He has written 150 introductions to books and many thousands of articles appearing in the scholarly and popular press. He is available for press interviews via his email.

    This article was originally published on FEE.org. Read the original article.


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  • Money, It Turns Out, Is a Practical Art

    Posted on by Azrael Comment

    If you read on the topic of money’s history from any mainstream textbook, you will already know the drill. In the past, money took many forms. It was shells, pelts, salt, and various metals. Finally we got paper money, credit institutions, then central banks. At this point, we are told, history was complete. The final and best form had arrived.

    The state would be in charge of money forever. All that was left was to have it managed in a way that better served our needs. People argued about systems of government management. Maybe a rule of some sort, based on quantity or the gold price or some other scheme. The system can be reformed, but the idea of treating money as a technology to be managed by the market – well, let’s just leave that to utopians like F.A. Hayek.

    Frozen in Place

     

    But look what actually happened. From the time when money came to be nationalized by the state and managed by central banks, roughly 100 years ago, the improvements stopped. Everything else got better: cars, flight, communication, homes, indoor environments, distribution of all essentials from food to clothing to finance. What did not improve was the money itself. In fact, it became worse.

    This is for a reason. The nationalization of money froze it in place. It was no longer subject to the pressure that free enterprise places on everything else. It was the great exception (there were other exceptions too, like schools and courts). It was stuck. In the 21st century, we were using the same core money technology as we were using in the early part of the 20th century. Hardly anyone thought anything of it. Surely we had come to the end of history.

    The consequences were not only that money never got better. The nationalization of money led to a huge increase in government debt, wild swings in credit cycles, inflation, and even war because government no longer had to tax people for funds but rather could print it without limit. All of this ended up eating away at liberty itself, growing government beyond what any liberal society should tolerate, and fed human rights abuses.

    Then Came Crypto

    From the time that Bitcoin became viable, however, monetary theory would never be the same. In the years since that time (2009), I’ve noticed a gradual change taking place. We used to think about money as somehow existing in a finalized form. No more. It is now being thought of as we should have thought about it all along, as a technology that can become better in response to human needs.

    In the 19th century, the word technology was not in common use. Instead a different phrase was popular: the practical arts. I think it is better. Inventing new things for human use is an art form. But it is not art just for admiring. It is art for using, art to make life better, a tool to enable a better path forward for all.

    The practical arts today involve new apps, new buying options, new ways to communicate, new modes of transportation, and new markets. They make things cheaper, better, and more adaptive to our needs. Entrepreneurs compete to find better ways of serving us through the practical arts.

    Thanks to the rise of cryptocurrency, the practical arts are being applied to reinventing money itself. It is going on every day, with thousands of companies innovating new monetary technologies. The big breakthroughs include: the uniting of money with payment systems, the dramatic diminution of counterparty risk, the inclusion of the unbanked, the impossibility of censorship, the security of ownership, the absence of a central point of failure. We keep discovering new virtues.

    Cryptocurrency opened up the floodgates of monetary innovation a century after the enterprise had been shut down. F.A. Hayek wrote, “I have no doubt that competition would be much more inventive in providing the kind of monetary institutions needed for the proper functioning of markets.” He thought this might only happen by eliminating legal tender laws and dismantling central banks.

    Perhaps the most remarkable thing about cryptocurrency is that it unleashed competition without any reform of the system that still operates from the top down. No law was repealed, no plan was enacted, no new reforms were passed. It was as if a Maserati had sudden driven up alongside a fleet of Model Ts.

    When will mainstream monetary theory adapt to the new reality? Check back in ten years.

    When I was in Tel Aviv, Israel, recently, I did a full interview on a popular podcast on this topic and its meaning for our future.

     


    Jeffrey A. Tucker

    Jeffrey Tucker is Director of Content for the Foundation for Economic Education. He is founder of Liberty.me, Distinguished Honorary Member of Mises Brazil, economics adviser to FreeSociety.com, research fellow at the Acton Institute, policy adviser of the Heartland Institute, founder of the CryptoCurrency Conference, member of the editorial board of the Molinari Review, an advisor to the blockchain application builder Factom, and author of five books, most recently Right-Wing Collectivism: The Other Threat to Liberty, with a preface by Deirdre McCloskey (FEE 2017). He has written 150 introductions to books and many thousands of articles appearing in the scholarly and popular press. He is available for press interviews via his email.

    This article was originally published on FEE.org. Read the original article.


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