Bitcoin on Friday averted a split into two currencies after its network supported an upgrade to its software that would enhance its ability to process an increasing number of transactions.
Look at the modus operandi of today’s internet giants — such as Google, Facebook, Twitter, Uber, or Airbnb — and you’ll notice they have one thing in common: They rely on the contributions of users as a means to generate value within their own platforms. Over the past 20 years the economy has progressively moved away from the traditional model of centralized organizations, where large operators, often with a dominant position, were responsible for providing a service to a group of passive consumers. Today we are moving toward a new model of increasingly decentralized organizations, where large operators are responsible for aggregating the resources of multiple people to provide a service to a much more active group of consumers. This shift marks the advent of a new generation of “dematerialized” organizations that do not require physical offices, assets, or even employees.
The problem with this model is that, in most cases, the value produced by the crowd is not equally redistributed among all those who have contributed to the value production; all of the profits are captured by the large intermediaries who operate the platforms.
Recently, a new technology has emerged that could change this imbalance. Blockchain facilitates the exchange of value in a secure and decentralized manner, without the need for an intermediary.
Bitcoin’s miners have signaled their support for the so-called Bitcoin Improvement Proposal (BIP) 91, avoiding a split of bitcoin into two blockchains. The miners represent a network of computer operators who secure the blockchain or a public ledger of all bitcoin transactions
BIP 91 is the first step toward a larger effort to upgrade bitcoin through a software called SegWit2x. On Friday, the support for BIP 91 reached nearly 100 percent, exceeding the required threshold of 80 percent, according to analysts and market participants.
Some investors have warmed to bitcoin, wooed by its explosive performance and potential to compete with gold and government-issued money as a means to store value. Demand for bitcoin has grown in eight years to a market capitalization of more than $40 billion.
But fears about the bitcoin split dampened demand for bitcoin in recent weeks. After hitting record high near $3,000, bitcoin dropped as low $1,830 BTC=BTSP on the Bitstamp platform. On Friday, it traded at $2,647.
The software upgrade attempts to address the bitcoin network’s limitations in processing millions of daily transactions. Bitcoin’s network has not kept pace with its growth and is unable to process all the transactions fast enough.
BIP 91 unleashes the next wave of innovation because it has been a little bit stagnant of late for bitcoin. Before BIP 91’s endorsement, some bitcoin investors feared it could split into two independent currencies because core developers of the network and the miners each wanted different ways to increase bitcoin’s scale.
A compromise between the two groups has been reached through SegWit2x. Bitcoin now has a clear run to add features that allow for faster transactions with lower costs. The upgrade to bitcoin’s network will not occur until autumn, because several things need to happen before the new software is activated.
Market participants have complained about the delay in transactions. A single bitcoin transaction costs on average 83 U.S. cents to execute, which means micropayments are not feasible on the network. The network is also limited to roughly seven transactions per second. In comparison, Visa on average handles 2,000 transactions per second.
How Blockchain Works
Here are five basic principles underlying the technology.
Each party on a blockchain has access to the entire database and its complete history. No single party controls the data or the information. Every party can verify the records of its transaction partners directly, without an intermediary.
Communication occurs directly between peers instead of through a central node. Each node stores and forwards information to all other nodes.
Transparency with Pseudonymity
Every transaction and its associated value are visible to anyone with access to the system. Each node, or user, on a blockchain has a unique 30-plus-character alphanumeric address that identifies it. Users can choose to remain anonymous or provide proof of their identity to others. Transactions occur between blockchain addresses.
Irreversibility of Records
Once a transaction is entered in the database and the accounts are updated, the records cannot be altered, because they’re linked to every transaction record that came before them (hence the term “chain”). Various computational algorithms and approaches are deployed to ensure that the recording on the database is permanent, chronologically ordered, and available to all others on the network.
The digital nature of the ledger means that blockchain transactions can be tied to computational logic and in essence programmed. So users can set up algorithms and rules that automatically trigger transactions between nodes.
But the most revolutionary aspect of blockchain technology is that it can run software in a secure and decentralized manner. With a blockchain, software applications no longer need to be deployed on a centralized server: They can be run on a peer-to-peer network that is not controlled by any single party. These blockchain-based applications can be used to coordinate the activities of a large number of individuals, who can organize themselves without the help of a third party. Blockchain technology is ultimately a means for individuals to coordinate common activities, to interact directly with one another, and to govern themselves in a more secure and decentralized manner.
There are already a fair number of applications that have been deployed on a blockchain. Akasha, Steem.io, or Synereo, for instance, are distributed social networks that operate like Facebook, but without a central platform. Instead of relying on a centralized organization to manage the network and stipulate which content should be displayed to whom (often through proprietary algorithms that are not disclosed to the public), these platforms are run in a decentralized manner, aggregating the work of disparate groups of peers, which coordinate themselves, only and exclusively, through a set of code-based rules enshrined in a blockchain. People must pay microfees to post messages onto the network, which will be paid to those who contribute to maintaining and operating the network. Contributors may earn back the fee (plus additional compensation) as their messages spread across the network and are positively evaluated by their peers.
Similarly, OpenBazaar is a decentralized marketplace, much like eBay or Amazon, but operates independently of any intermediary operator. The platform relies on blockchain technology to ensure that buyers and sellers can interact directly with one another, without passing through any centralized middleman. Anyone is free to register a product on the platform, which will become visible to all users connected to the network. Once a buyer agrees to the price for that product, an escrow account is created on the bitcoin blockchain that requires two out of three people (i.e., the buyer, the seller, and a potential third-party arbitrator) to agree for the funds to be released (a so-called multisignature account). Once the buyer has sent the payment to the account, the seller ships the product; after receiving the product, the buyer releases the funds from the escrow account. Only if there is an issue between the two does the system require the intervention of a third party (e.g., a randomly selected arbitrator) to decide whether to release the payment to the seller or whether to return the money to the buyer.
There are also decentralized carpooling platforms, such as Lazooz or ArcadeCity, which operate much like Uber, but without a centralized operator. These platforms are governed only by the code deployed on a blockchain-based infrastructure, which is designed to govern peer-to-peer interactions between drivers and users. These platforms rely on a blockchain to reward drivers contributing to the platform with specially designed tokens that represent a share in the platform. The more a driver contributes to the network, the more they will be able to benefit from the success of that platform, and the greater their influence in the governance of that organization.
Blockchain technology thus facilitates the emergence of new forms of organizations, which are not only dematerialized but also decentralized. These organizations — which have no director or CEO, or any sort of hierarchical structure — are administered, collectively, by all individuals interacting on a blockchain. As such, it is important not to confuse them with the traditional model of “crowd-sourcing,” where people contribute to a platform but do not benefit from the success of that platform. Blockchain technologies can support a much more cooperative form of crowd-sourcing — sometimes referred to as “platform cooperativism”— where users qualify both as contributors and shareholders of the platforms to which they contribute. And since there is no intermediary operator, the value produced within these platforms can be more equally redistributed among those who have contributed to the value creation.
With this new opportunity for increased “cooperativism,” we’re moving toward a true sharing or collaborative economy — one that is not controlled by a few large intermediary operators, but that is governed by and for the people.
There’s nothing new about that, you might say — haven’t we heard these promises before? Wasn’t the mainstream deployment of the internet supposed to level the playing field for individuals and small businesses competing against corporate giants? And yet, as time went by, most of the promises and dreams of the early internet days faded away, as big giants formed and took control over our digital landscape.
Today we have a new opportunity to fulfill these promises. Blockchain technology makes it possible to replace the model of top-down hierarchical organizations with a system of distributed, bottom-up cooperation. This shift could change the way wealth is distributed in the first place, enabling people to cooperate toward the creation of a common good, while ensuring that everyone will be duly compensated for their efforts and contributions.
And yet nothing should be taken for granted. Just as the internet has evolved from a highly decentralized infrastructure into an increasingly centralized system controlled by only a few large online operators, there is always the risk that big giants will eventually form in the blockchain space. We’ve lost our first window of opportunity with the internet. If we, as a society, really value the concept of a true sharing economy, where the individuals doing the work are fairly rewarded for their efforts, it behooves us all to engage and experiment with this emergent technology, to explore the new opportunities it provides and deploy large, successful, community-driven applications that enable us to resist the formation of blockchain giants.
A smart contract is an agreement in digital form that is self-executing and self-enforcing. Let’s say that I want to bet about who is going to win the Super Bowl. I think the Eagles are going to win the Super Bowl, and so we bet $100. Now let’s just assume for a moment that it is a legal transaction — we are in Las Vegas or someplace where you can make a sports bet. So the end of the season comes along, the Eagles do not win the Super Bowl because, of course, they never do, and the counterparty comes to me and says, “Okay, where is my hundred dollars?” If it’s a normal contract, I might say, “Well, I was just kidding,” or “Well, I actually don’t have the money.” He might have to go into court to sue me to enforce the contract.
With a smart contract, we could do that same agreement digitally, so that the moment the Super Bowl happens and it’s clear who won, the contract is automatically enforced. The money gets transferred. There is no party — neither of us, nor even someone else in the middle, an intermediary — that makes the decision. The contract is just automatically enforced. And it can be applied, this approach of smart contracts, to any kind of agreement. Many things are contracts — the rental agreement that you might use for a home, your employment agreement, your business transactions in a company, purchases. Smart contracts, in theory, could take any of those and make them automatically enforceable.
We talk about four different categories of increasingly decentralized and increasingly automated contracts. The first we would call just an electronic agreement. So you go to any website that you sign up for, you click a button, and there is a link there. And you can see, typically, an incredibly long and detailed contract that no one ever reads. But that is a human-readable contract. It’s the same contract you could get on paper. It just happens to be on a screen.
One step from that is a data-oriented contract. So let us now put the terms of the contract in machine-readable form, which limits what we can do in that contract, but we can do it in ways that computers can at least understand what it means to say “a hundred dollars,” or what it means to say, “purchase this share of stock,” or something. The next step is a computable contract. So now we are at the point where the machines can, to some extent, process and enforce the contract. But there is still the fallback of the legal system if something goes wrong.
A smart contract, in theory at least, takes away the legal system entirely. Now there is nothing but that digital agreement. That is the entirety of the relationship, and everything from the negotiating of the agreement, all the way to the full enforcement and clearing of the agreement, happens digitally.
There are two primary reasons why people are excited. The first is about gains in efficiency. Any time you can automate a process and remove the human element, there is the possibility of transformative increases in efficiency and reliability. Just think about what computerization has done for other areas of our lives.
Second, people are also excited about the possibility of removing human institutions, and in particular government institutions, from an important function that they currently play. Right now, contracts depend on a legal system administered by a government. This requires trust in a coercive and fallible authority. So for the same reason that bitcoin enthusiasts are excited about the prospect of currency without a government, smart contract enthusiasts are excited about the prospect of contracts without a government-run legal system.
We think the answer is yes, that smart contracts are legally enforceable. There is no reason to think one cannot make a contract in computer code or electronically. We have been doing that for quite a long time now. There is a little bit of a complication because we normally think of contracts as agreements that are intended to be legally enforceable, and smart contracts are, by their nature, intended not to be legally enforced. But we still think that they are changing the rights and obligations between the parties. And that is the important thing for something to be a contract in the legal sense.
There are a bunch of legal mechanisms to reverse transactions or disgorge wrongfully obtained funds, but these are legally quite different structurally and potentially more difficult. So by reversing who stands as plaintiff and who is trying to legally change the situation, we really do end up shifting the complexion of the legal dispute that might arise.
This is a good example of partly what got us interested in this. Smart contracts are a technical innovation, and the enthusiasts, a lot of the engineers, say, “Well, this has nothing to do with the legal system and legal enforcement.” The reality is that it actually forces us to take a closer look at just what the legal system does. And it creates all these kinds of fascinating new issues.
If you read a lot of the breathless pronouncements, smart contracts have basically solved the problem of contract law. We no longer need the legal system or government. We don’t have any uncertainty anymore, because contracts are automatically enforced. Well it is, of course, not that simple.
There are two broad classes of challenges that we talk about in the paper — one is a set of legal doctrinal issues. Contract law has all sorts of requirements. For example, we cannot make an illegal contract. Let us say we have a contract to kill my mother-in-law. No court is going to enforce that. It is an illegal contract, even if we might write it down and sign it and seal it and so forth. There are other limitations. For example, a contract has to have what is called consideration. Someone has to give you something in return for the promise. Contracts cannot be unconscionable, and so on and so forth.
It turns out if you go through all these legal doctrines and say — ‘Well, how does that apply in a system where, again, the contract just enforces itself on this distributed network, with no one making a decision in the middle?’ — you get lots of confusion and lots of problems. So those are the doctrinal issues.
Then there are a huge set of practical issues. The reality is, even though we think machines can render contracts effectively, there are lots of situations where they cannot. Some of those are in situations that are fairly obvious — for example, if a contract says something like ‘you’ll use best efforts,’ which is frequently included in human contracts. But what does that actually mean? How do you reduce that to computer code? Even things that seem simpler to apply, it turns out that people cannot necessarily foresee what is going to happen in the future. So when you put it in that automatically executed digital form and just let the machine run, it creates all sorts of problems in situations we’re already starting to see.
The final thing is, when people negotiate a contract in real life, a traditional contract, there is still the possibility they can re-negotiate it. Maybe at this point in time we do a deal, and we’re certain we want it to be enforced. But then a month later, things change and we both say, ‘All right, no, it’s in our mutual interest to change the contract, or maybe even to get out of the contract entirely, because things have changed.’ The smart contract is not smart enough to do that, unless the parties build into the smart contract code at the beginning the possibility for that modification. Those are just a few examples of the kinds of problems that come up.
There’s a whole range of situations, from the classic kind of bug, to things that are uncertain — where humans intended one thing in the contract, but the machines interpreted it a different way. Or they can’t distinguish what people really intended, even if the language seems clear. One of the functions that courts provide in the regular legal system, in contract enforcement, is you can get testimony. You can interpret and look at the terms of the agreement and figure out what it really means.
Ethereum on the blockchain is a fascinating example. There is this something called the DAO, which stands for Distributed Autonomous Organization. It was a virtual crowdfunding system like Kickstarter, where people contributed currency — in this case crytpocurrency, the virtual currency of Ethereum called ether. People put up about $150 million worth of ether at the time into this system. And the idea is they would be able to vote on projects that would get funded and so forth.
Someone found a bug in the code. They were able to exploit the code in a way that they could siphon off about $60 million of that ether into their own DAO, and then they were going to be able to take it and use it for whatever, or convert it into other currencies. The problem is that, according to the code of the system, it was a legitimate transaction.
The only way to know that that was theft and not a real transaction was for a human to look at it. The machines had no way of knowing. So in order to fix that problem — not to have people lose $60 million that they had put up — the developers of Ethereum had to basically break the whole system, not just the DAO. All of Ethereum had to do what’s called a hard fork, to basically make it as if the transactions had never happened. And that potentially undermines the whole point of smart contracts and of these blockchain systems, which is the notion of immutable distributed trust.
You can think of there being two ways that you can make a commitment. Imagine I say, ‘I’ll meet you at the bottom of the hill, I promise.’ That’s one way of making a commitment, and it binds me by creating a certain kind of obligation. A different way is I might say, ‘I’ll meet you at the bottom of the hill’ and then just throw myself tumbling down the hill. That is also committing myself to seeing you at the bottom, but it is a different way of doing so, and it is a little blunter. It may be more efficient, but it is not exactly a promise, and it serves a very different function. That’s a rough analogy, but I think the commitment in smart contracts is more like that, and less like the promise.
Smart contracts force us to re-examine just what contract law is actually doing. Is it basically prospectively creating new rights, or is it retrospectively — as we argue — creating a mechanism for remediation when something goes wrong? And even though we’re looking at what is in existing contract law, smart contracts actually help us unpack that.
It is hard to say exactly because the potential of this technology is so broad — and certainly situations where it is easier to implement the agreements in digital form. The initial use of smart contracts is for bitcoin. And bitcoin is very strictly limited in what you can do with smart contracts. It allows you to basically transfer bitcoin back and forth, using the smart contract mechanism to enforce that, and it is tightly limited.
These newer smart contract platforms open up a tremendous amount of new possibilities, but that also leads to more things that can go wrong. So really, I think, what we need to see is the development of best practices, development of things like templates — ways to basically create hybrids where you can actually build into the smart contract. For example, I talked about the opportunity to re-negotiate or potentially the opportunity to bring in dispute resolution, whether through a formal court or more informal, say, arbitration mechanism.
The reason that we are stumbling is that the opportunity here is just immense. And contracts are everywhere in the world today, everywhere in our life — and especially in the digital world, where almost every interaction is a contract. We clearly are going to see smart contracts get used more and more widely.
And so it is really less of a question of deciding what segment of human activity smart contracts will be used for, but more thinking about how they can be implemented in a way that’s sensible, that addresses these kinds of issues, and that understands the legal system still plays a vital and valuable role.
If what we want is the thing that the legal system does, the thing that courts do relatively effectively, let us still use that mechanism. There is no reason to get rid of it. If what we want, though, is something different — we want that definitive commitment, what Nico was talking about — then smart contracts are great. We are just at the early stages of figuring out how those things get divided.
Smart contracts are an important way or access point for understanding what contract law does for us. A lot of people think the point of contract law is just to make sure that people actually do what they say they are going to do. Or they see it as a mechanism to ensure that people either perform or pay some sort of damages.
If you think of contract law in this way, as just a mechanism to ensure a certain kind of result, then smart contracts will look like they can serve this function and maybe serve it more efficiently. But this all assumes that the point is to ensure a certain kind of result takes place. If what we want to do is regard our transactions ex post and think not about creating repercussions but adjudicating retrospectively what happened, what went wrong, and how we are going to fix it, then it seems like smart contracts are just not designed to serve that function. That’s what we want the legal system to do.