In the beginning, there was the promise that blockchain-supported smart-contracts could disintermediate the powers that be and replace them with a self-organising decentralised system where every contract entered into could be depended upon to perform as expected, with risk and costs entirely eliminated.
Furthermore, it was thought, both human and state involvement could be taken out of the process too. Instead, we’d achieve an autonomous financial utopia within which capital flowed from each according to his ability, to each according to his needs — guided only by faceless protocols and algorithms.
Yet, from the beginning, there was an inconvenient truth buried in the promises being made by blockchain advocates.
One always needs a state or at the very least a powerful institution to administer and enforce legal contracts when externalities hit and terms and conditions breakdown or arbitration fails — especially when contracts are widespread or involve the retail segment directly. Furthermore, contracts don’t reduce liabilities for anyone if the humans involved have failed to comprehend the T&Cs they’ve inadvertently signed up or feel somehow they’ve been tricked out of their entitlements.
Contract comprehension and the cost of taking disputes to trial is and always will be the fly in the ointment of the smart-contract revolution.
This reality, however, has largely escaped the technologists.
Under pressure to resolve the arbitration problem the boy genius behind the smart-contracting public blockchain project Ethereum, Vitalik Buterin (22), has finally presented the world with a potential solution — having seemingly swallowed a law degree in a matter of months (whilst also publicly speaking at every blockchain conference under the sun, blogging on reddit, coding ethereum and running a crypto empire).
Unsurprisingly, the solution stays true to the open decentralised promise of the system. The answer? A decentralised court of course.
One crypto-institution that would be very useful for a large set of different applications is a mechanism by which a user could ask a question, expressed in the form of English text, and have a decentralized mechanism, perhaps based on schellingcoin, Martin Koppelmann’s ultimate oracle, subjectivocracy (a very similar concept to slock’s DAO splitting) or some other scheme with similar properties determine the answer, and then send a callback and a log to the user who asked the question. To achieve scalability, a multi-stage scheme where only a few randomly selected judges look at each question by default, and are incentivized by the threat of a larger “supreme court” contradicting them, is probably optimal.
Buterin envisages the use cases as follows:
- Using smart contracts for events that are potentially highly subjective
- Arbitration in decentralized crowdsourcing and on-demand economy applications
- Storage or distribution of funds (eg. one use case is a will where you do not want to force the recipient to set up a private key or learn about ethereum unless they actually need to)
- As an emergency backstop measure to get funds out of a smart contract if they are stuck for a long timeNote that in order to use the decentralized court, you do not have to give it complete power over you or your applications. For the last usecase, for example, you can set up a system where the decentralized court can only be invoked if a contract has not seen any activity in more than three months. So each developer has the freedom to make very fine-grained tradeoffs between where they trust their code and where they want to trust the decentralized court.
We are certainly not lawyers (and we do welcome legal feedback on this) but it seems patently clear that whether a court is centralised or decentralised, or whether it picks jurors more randomly than currently, doesn’t negate from the key admission here: blockchain smart-contracts are useless unless they’re supported by some form of legal framework and judicial process, which is ultimately defended by a publicly funded process backed by a state. Furthermore, whether it’s centralised or decentralised, materialised or dematerialised, the costly risk of arbitration makes up a significant chunk of the expense in contract-based transactions.
Buterin says his solution (he is a solution type) is not meant to be a full competitor to the traditional court system… just something that is supposed to compete with private arbitration more than anything else. And yet, the system by his own admission ultimately depends on the threat of a larger “supreme court” contradicting the rulings of the decentralised court. Not only is that an indirect state subsidy for his decentralised court system, it’s also an admission finally that smart-contracts do bear arbitration risk (and thus costs) even on blockchains:
“…the typical decentralized court use case is relevant to only a few parties and the costs of gathering information are higher (eg. requiring the court to determine the meaning of “reasonable” is entirely expected and will probably happen frequently); hence, to compensate, the fees are higher as well, though in some areas they will clearly be worth it (eg. if the alternative is risking losing 1100 ETH).”
These are significant admissions by the blockchain radicals who had initially claimed their systems were fool proof, not least because so many of the techno-sourced solutions were dreamt up in idealised scenarios or microcosms detached from the real and messy world of competing legal structures, fallible people and corrupted agents, whilst also being removed from the critical judgment of experts in different fields. (FYI, Vitalik, a decentralised court is kinda an oxymoron.)
The legal system, however, can’t just be ignored, nor can the jurisdictional conflicts which arise with cross-border sovereign transactions. After all, if a decentralised smart-contract system ultimately depends on a “supreme court” system with an enforcement division in tow, it’s not a self-organising system at all.
Dispute resolution without such support would take on an entirely different and unappealing course. The threat would have to come from elsewhere. Most likely, in the form of a devolution to a Wild West framework, complete with bounty hunters, mercenaries, guns, the threat of being run out of town or shunned, death threats and on-the-spot Judge Dredd-style judgments. It’s a system many countries have experienced in their past, but which have since walked away from with good reason (you know, to end the needless bloodshed, uncertainty, risk).
In fact, as Henry Farrell, associate professor of political science at George Washington University, eloquently outlined in 2014, we’ve already had a good clue of what would happen in the form of the moral decline and fall of Texan libertarian Ross Ulbricht, who went from a promising and gifted student to a murderous arbiter of the peace in just a few years in his unwitting and autocratic governance of the SilkRoad online black-market state he had created. As Farrell wrote back in 2015 about Ulbricht:
Ulbricht built the Silk Road marketplace from nothing, pursuing both a political dream and his own self-interest. However, in making a market he found himself building a micro-state, with increasing levels of bureaucracy and rule‑enforcement and, eventually, the threat of violence against the most dangerous rule‑breakers. Trying to build Galt’s Gulch, he ended up reconstructing Hobbes’s Leviathan; he became the very thing he was trying to escape. But this should not have been a surprise.
As the purveyors of blockchain resolutions continue to beat the drum about the potential of such systems to reduce clearing and settlement costs, it would be wise to remember just one thing.
When deconstructed to its core the world of money, finance and wealth is nothing more than a system of social contracts and agreements held together by social protocol, trusts and bonds. But contracts and agreements stand for nothing if counterparties don’t abide by legal and judicial protocols of the land or the club they subscribe to. Game theory dictates the costs of not cheating the system must be substantial if the system is to be kept in check and operational. But someone has to enforce those costs and penalties as well. The bigger and meaner the cheater, the bigger and meaner the enforcer needs to be: hence the state, the armies, the police forces and the prisons.
Bitcoin solves some of these problems, that’s true, but only because it makes it so inordinately expensive to cheat the system that it can never be scaled-up without reintroducing risks or trusts, which render it moot. It works only within a microcosm, or in a climate where the huge cost of supporting the network is worth it because the capital has been obtained so cheaply elsewhere. All it proves essentially is that for contracts to exist outside of a state-based jurisdictional framework, it will cost you.
This, though, was always to be expected. As Columbia Law School’s Katharina Pistor’s legal theory of finance maintains financial markets are legally constructed and as such occupy an essentially hybrid place between state and market, public and private. It’s when market dynamics are put in direct tension with commitments enshrined in law or contracts, that financial crises often emerge. Or as she puts it: financial crises represent times when “full enforcement of legal commitments would result in the self-destruction of the financial system”.
The cost of transaction, clearing and settlement therefore reflects the cost of contract enforcement, hence why cross-border transactions — which see counterparties interact with potentially conflicting legal and state frameworks, with their own enforcement mechanisms –have so many more frictions and costs than domestic ones.
In the computing and tech world, “tension with commitments enshrined in law or contracts” has mostly been under-priced in terms of legal liability risk. When problems or conflicts emerge, the tech world’s way of dealing with inconsistencies is just to roll-out new terms and conditions on a take it or leave it basis. The old agreements are superseded with new ones, with zero negotiation or penalty. Users generally only have two options: agree to the new terms or discontinue the service.
But of course the system also relies on the fact that nobody reads the terms and conditions anyway. Indeed, if the public did start doing that, or heavens forbid negotiating on a group-wide level to defend their interests (see the Safe Harbourdebate), many of the frictions magically removed by digital network-based “solutions” would creep right back into the system rendering them unviable. Indeed, one of biggest darkest secrets of those peddling digital frictionless utopias, is that their ability to remove such frictions depends entirely on ensuring people never read the contracts but rather presume their interests are defended by the state.
But for the state to defend your contractual interest in a multilateral cross-border system there has to be — as per the Euro problem — a harmonised legal structure as well, with a single set of standard agreements. For as Pistor has stated before:
Indeed, from the perspective of Legal Theory of Finance, unbending and unbendable credible commitments may well increase rather than decrease the likelihood and/or severity of a crisis. Addressing this Law-Finance Paradox earlier rather than later by relaxing contractual commitments may prevent a full-scale crisis. This may to some extent undermine the credibility of many innovative instruments – but that might be socially desirable. It makes little sense to lend the coercive powers of the state to instruments if in doing so it transforms them into “weapons of mass destruction”.
Food for thought eh?