In the previous article of this series, we explored the concept of “smart contracts” (or, more precisely, “self-executing contracts”), and examined in-depth the two primary methods through which these contracts can possess “enforcement”: intelligent property and “factum” currencies. We also touched upon the limitations of smart contracts, and how a legal framework enabled by smart contracts might combine human discernment with automatic execution to attain optimal results. But what is the significance of these contracts? Why implement automation? What makes it advantageous to have our interactions governed and managed by algorithms rather than people? These are the challenging inquiries that this piece, as well as the subsequent one, aims to address.
A Narrative of Two Sectors
The foremost and most apparent advantage of employing internet-based technology to automate processes is the same benefit that we have observed the internet, along with Bitcoin, deliver in terms of communications and trade: it enhances efficiency and lowers entry barriers. A prime example illustrating this effect in the conventional realm is the publishing sector. In the 1970s, if you wished to author a book, you would encounter numerous opaque, centralized intermediaries that you needed to navigate through before your book reached a reader. First, you would require a publishing house, which would also take care of editing and marketing for you and provide quality assurance to the consumer. Next, the book would need to be distributed, and finally, it would be sold at each separate bookstore. Each segment of the process would take a substantial percentage; in the end, you would be fortunate to receive more than ten percent of the revenue from each copy as a royalty. Observe the phrasing “royalty,” suggesting that you, the author of the book, are merely another inconsequential element of the chain entitled to a few percent as a share rather than, well, the most crucial individual without whom the book wouldn’t even exist. Now, the situation has vastly improved. We now have distinct printing companies, marketing firms, and bookstores, each with a clear and defined role and ample competition within every sector – and if you are comfortable keeping it entirely digital, you can simply publish on Kindle and retain 70%.
Now, let’s examine a notably similar instance, yet in a completely different sector: consumer protection, or more specifically, escrow. Escrow is an essential function in trade, particularly in online commerce; when you purchase an item from a small online retailer or a seller on Ebay, you engage in a transaction where neither party has a significant reputation, hence, when you transfer the money, there’s no assurance that you will actually receive anything in return. Escrow provides a resolution: rather than sending the funds directly to the seller, you first send the money to an escrow agent, who then awaits your confirmation that you have received the item. If you confirm, then the escrow agent releases the funds, and if the seller confirms they can’t deliver the item, then the escrow agent reimburses you. If a conflict arises, an adjudication process initiates, and the escrow agent determines which party has the stronger case.
However, the current implementation of escrow is managed by centralized organizations, and is combined with numerous other functions. On the online platform Ebay, for instance, Ebay fulfills the role of providing a server for the seller to display their product page, a search and price comparison tool for items, and a rating system for buyers and sellers. Ebay also owns Paypal, which actually transfers the funds from the seller to the buyer and acts as the escrow agent. Essentially, this mirrors the situation that book publishing faced in the 1970s, although to be fair to Ebay sellers do receive substantially more than 10% of their earnings. So how can we create an optimal marketplace utilizing cryptocurrencies and smart contracts? If we wanted to take an extreme approach, we could build a decentralized marketplace, using a Diaspora-like model to enable a seller to host their products on a niche site, on their own server or on a Decentralized Dropbox implementation, employ a Namecoin-like system for sellers to safeguard their identities and maintain a web of trust on the blockchain. Nevertheless, what we aim for now is a more moderate and straightforward objective: to disentangle the function of the escrow agent from the payment system. Thankfully, Bitcoin offers a solution: multisignature transactions.
Presenting Multisig
Multisignature transactions permit a user to transmit funds to an address using three private keys, requiring two of those keys to access the funds (multisigs can also be configured as 1-of-3, 6-of-9, or any other combination, but in practice, 2-of-3 proves to be the most effective). The method of applying this to escrow is straightforward: establish a 2-of-3 escrow arrangement among the buyer, the seller, and the escrow agent, have the buyer deposit funds into it, and upon completion of a transaction, both the buyer and the seller sign a transaction to finalize the escrow. If a dispute emerges, the escrow agent determines which party has the more compelling case, and signs a transaction with them to transfer the funds. Technologically, this is somewhat intricate, yet fortunately, Bitrated has developed a platform that simplifies the process considerably for the average user.
Naturally, in its present form, Bitrated is not flawless, and it hasn’t seen substantial activity in Bitcoin commerce. The interface might not be as user-friendly as it could be, especially since many individuals are not accustomed to the notion of storing specific per-transaction links for several weeks, and it would be greatly enhanced if it could be integrated into a comprehensive merchant package. One idea could be a KryptoKit-like web application, displaying each user a list of “open” purchases and sales and providing buttons for “finalize,” “accept,” “cancel,” and “dispute” for each one; users would then be able to engage with the multisig system just as if it was a traditional payment processor, but subsequently receive a notification to finalize or raise a dispute regarding their transactions after a few weeks.
However, if Bitrated optimizes its interface and begins to achieve large-scale acceptance, what will that lead to? Once more, the answer lies in diminished entry barriers. At present, entering the consumer escrow and arbitration market is challenging. To operate as an escrow service, you essentially must construct an entire platform and an ecosystem, so thatconsumers and vendors function through you. You also can’t merely serve as the one holding the funds – you additionally must be the one disbursing the funds initially. Ebay is required to possess and manage Paypal to enable a significant portion of its consumer protection to operate effectively. With Bitrated, everything shifts. Anyone has the opportunity to become an escrow agent and arbitrator, and an Ebay-like marketplace (perhaps CryptoThrift or the upcoming Egora) can establish a rating system for arbitrators alongside buyers and sellers. Alternatively, the system might manage arbitration in the background akin to how Uber oversees taxi operators: any individual could become an arbitrator following a screening process, and the system would automatically reward arbitrators with excellent ratings and dismiss those with poor ratings. Charges would decrease, presumably significantly beneath even the 2.9% imposed by Paypal on its own.
Smart Contracts
Smart contracts generally adopt this fundamental concept and advance it considerably. Instead of depending on a platform like Bitfinex to hedge one’s Bitcoin assets or speculate in either direction using high leverage, one can utilize a blockchain-based financial derivatives agreement with a decentralized order book, eliminating the involvement of a central entity to collect any fees. The continuous expenses of sustaining an exchange, coupled with operational security, server management, DDoS protection, promotional and legal costs, could be supplanted by a single effort to compose the contract, likely in fewer than 100 lines of code, and another one-time endeavor to create an appealing interface. From that juncture onward, the entire structure would be free aside from network fees. File storage services like Dropbox could be similarly substituted; however, since hard disk space incurs expenses, the system wouldn’t be entirely free, but it would likely be considerably less costly than it presently is. It would also assist in leveling the market by simplifying participation on the supply side: anyone with a large hard drive, or even a modest hard drive with available space, can simply install the application and begin earning income by renting out their unused capacity.
Rather than depending on legal agreements that utilize costly (and often, especially in international cases and impoverished regions, inefficient) court systems, or even reasonably priced private arbitration services, commercial relationships can be regulated by smart contracts where those elements of the contract necessitating human interpretation can be divided into many specialized sections. There could be judges focused on determining whether or not a product has been dispatched (ideally, this would be the postal system itself), judges concentrating on ascertaining whether web application designs fulfill specifications, judges specializing in evaluating certain categories of property insurance claims with a $0.75 fee by reviewing satellite imagery, and there would be contract drafters adept at intelligently merging each aspect. Specialization offers advantages and is the reason society progressed beyond chasing bears with stone tools and foraging for berries, but one of its drawbacks has always been the necessity for intermediaries to manage and operate, including intermediaries specifically required to oversee the interactions among those intermediaries. Smart contracts can eliminate this latter category nearly entirely, fostering an even greater level of specialization, alongside reduced barriers to entry within each now-consolidated category.
Nonetheless, this enhancement in effectiveness is just one facet of the equation. The other facet, and arguably the more significant one, relates to a subject that many cryptocurrency proponents hold in high regard: minimizing reliance on trust. We will explore that in the next entry of this series.
