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Feasibility of the Smart Contract Economy

Casper Labs


Feasibility of an economy driven by smart contracts deployed on a public blockchain is, essentially, unknown. While it is already possible to make a dApp a working reality, a look at the number of users[1] reveals that most of the existing user base is engaged with gambling or transferring/converting cryptocurrency (Steemit, a microblogging platform, is a notable and interesting exception.)

This type of engagement is highly speculative and is driven by perceived future value to be delivered by the blockchain, as otherwise the proceeds of gambling and speculative trading will turn out to be worthless. The problem facing developers of smart-contract enabled blockchains is finding a way to unlock this perceived value and deliver a platform for powerful, simple to deploy applications that fill market niches that are currently poorly served by existing institutions, businesses and markets.


Possible routes to a solution to the feasibility problem are obscured by a lack of coherent high-level business frameworks in the blockchain space. As a preliminary attempt, we can attempt to categorize business relationships (i.e., exchange of money for services, goods or fulfillment of legal obligations) along two dimensions capturing costs of breaking trust. The first, reflecting potential extrinsic costs that could be inflicted on the deviating party, we will call “Rule of Law.” The second, reflecting intrinsic investments and the potential sunk costs of withdrawal from the relationship, we will call “Relational Strength.”

The dimension of Rule of Law reflects two considerations. Degree of regulatory oversight and legal regimentation of the exchange is the formal component. However, in reality, poor access to courts, lack of impartiality and risk of outsize legal expenses must be taken as complicating factors in evaluating where a particular business relationship falls. It should be noted that these considerations are not inherent to the relationship itself, but rather imposed from the outside by the society in which the relationship is situated.

The dimension of Relational Strength reflects two considerations, much like Rule of Law, but these considerations are internal to the relationship. One is the length of a typical relationship of the two (or possibly more) parties involved, in particular since long relationships make reputation important. The other is the cost of investments necessary to establish or maintain the relationship, such as costs arising from investment in relationship-specific physical capital or training.

We will now consider a few examples in detail.

Banks (high Rule of Law, high Relational Strength) — a simple personal checking account in a neighborhood bank comes with oversight and insurance from multiple government agencies (the Fed, FDIC, etc.). Customers also tend to stay with the same bank for a very long time — perhaps their entire life.

Online retailers (medium Rule of Law/medium Relational Strength) — an account with Amazon may be a long-term relationship, but there’s only a small difference in using the same account twice or switching between accounts. Moreover, while there is recourse to the courts, litigation over a poorly made pair of shoes that is delivered late is not a serious option.

Government agencies (high Rule of Law/high Relational Strength) — all U.S. citizens are subject to various legal obligations imposed by both Federal and State governments, which are rigorously enforced and last the entire lifetime, for most.

Flea markets (low Rule of Law/low Relational Strength) — while it may be difficult to win a case against Amazon for a pair of mismatched shoes, it is downright impossible if said shoes were purchased from a virtually anonymous vendor in a chaotic street market.

Finally, let us take a look at where some other business relationships may be located in our framework.

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What does this have to do with smart-contract enabled blockchains?

Deployment of smart-contracts on a public blockchain is frequently seen as a means of dis-intermediating centralized institutions, such as banks. This vision is heavily influenced by the “cypherpunk” ideas that entwine business considerations and political ideology in a way that may be seen as threatening by governments, should blockchain technology achieve the potential perceived by its proponents. As Vlad Zamfir points out,[2] this ideological entanglement renders the prospect of building businesses on top of the blockchain extremely risky, in part because open source projects still typically rely on core development teams that may be vulnerable to government prosecution. A direct attack on large institutions is unwise because these institutions have significant influence on government policy.

Another obstacle on the path to disintermediation is that centralized third-party institutions in developed countries do not realistically present the danger imagined by extreme decentralization advocates. Simply put, most people do not give a second thought to the possibility that their bank might cheat them, or go bankrupt, without them receiving their money back either in the form of an FDIC payout or a court settlement. Besides, banks can make it very convenient to develop and maintain a relationship with them (e.g., overdraft protection, easy-to-use unified UX, etc.). There is no organic demand for disintermediation of banks.

Just as with “institutionalized” relationships of the kind customers have with their banks or their doctors, either legal recourse or the value of a stable long-term relationship makes most people relatively satisfied with online retailers. Supply chain relationships can last for decades and resemble vertical integration.

Where do smart contracts fit?

Despite the apparently bleak outlook for the public blockchain in its role as the great disruptor and decentralizer, there is an opportunity to enter and revolutionize an entirely different niche. That niche is distributed markets. Blockchain, in its current form, enables trade in arbitrary digital assets between semi-anonymous participants (while it is frivolous, CryptoKitties is a simple proof of concept) in a way that was not possible before. Even Steam could one day disappear and take digital assets one “owns” with it, but this is unlikely to happen with a distributed market. Moreover, one cannot be banned from a distributed market.

Distributed markets are the future evolution of a fundamental feature of human life — the trading hub. A future blockchain can provide the digital equivalent of space (the blockchain itself), regular weights & measures (cryptographic security) and arbitration of contracts (smart contracts), much like a well-organized street market might have done a hundred years ago. The advantage it offers, besides enabling trade in entirely new classes of goods, is that it can bring features of strong Rule of Law (enforcement by code) and high Relational Strength (by virtue of being trust-less) to a spontaneous marketplace without any need for complex government institutions or high investment (on the part of the participants) to support them.

Common examples of future applications (and why they do not fit)

Money transfer — while Bitcoin or Ethereum may be useful for circumventing capital controls or storing value in times of hyperinflation, precisely these uses make it unlikely that this application will persist indefinitely, at least in countries with strong law enforcement agencies.

Supply chain tracking — a public blockchain is unnecessary for supply chain relationships that last years, but may have some use in certain cases (e.g., Amazon vendors ordering various small household goods from different small manufacturers in China).

Better examples of future applications

Personal accountability — a problem solvable by smart contracts is incentivizing strangers to meet (e.g., on a first date) once an agreement to do so is reached. Two individuals and a third party (say, a restaurant) deposit tokens to a contract that returns the deposits, with profits for the third party and perhaps the creator, once the individuals both use each other’s smartphones to confirm their arrival, with automated verification by the third party that both are accessing their Wi-Fi network. The blockchain solution avoids concerns with secondary uses of personal data by a centralized platform, while enabling relatively easy deployment of such contracts, without having to maintain a centralized server. While this example may appear limited, it illustrates a case where there is no Rule of Law at all (short of writing a notarized contract) and very low Relational Strength.

Scientific citation tracking — currently, the scientific community is facing the challenge of making their findings more accessible both to the general public and to other scholars. While free non-profit journals may be a part of a future solution, such a solution would almost certainly require submission fees, limiting access for scholars with limited institutional funding. However, blockchain enables micropayments and verification of citations in published papers. That is, each contract-aware paper published to the blockchain would result in appropriate transfers to scholars being cited. Should the paper itself be highly cited, the author will recoup these payments from future citations. The weakness of the system — the need to establish the norm that papers are published to the blockchain, rather than “off-chain” — could be mitigated by a system of bounties for early adopters. Similarly to the previous example, there is little recourse to copyright law and often only a fleeting relationship between one scholar and the scholars he cites. A third-party non-profit publishing consortium could implement a system along these lines, naturally, but presents the risk of capture by factional interests (e.g., proponents of a particular theory) that is acutely felt in academia, whereas a blockchain publication system could even be integrated with a universally available peer-review mechanism (perhaps limited to scholars with high citation counts, immediately verifiable on the blockchain.)



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