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The Pencil, the Brick, and the Law
Others to come
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Index of Talks
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The Pencil, the Brick, and the Law Others to come |
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Introduction As Hernando De Soto highlights in The Mystery of Capital, the people of the third world do not suffer from a lack of assets; rather, they suffer from a lack of capital. As a simple example, the house you live in, from which no one would attempt to evict you, is an asset. A mortgage on that house would be capital. But just because no one can evict you from your house, this does not mean a bank dares to accept it as collateral for a loan. The distinction is one of property rights transferrability, i.e., the ability to engage in binding contracts such that the new owners could indeed evict you as part of the contract. Because binding contracts for ownership transfer lie at the heart of capital formation, if traditional contracts were supplemented and/or supplanted with smart contracts, which leverage the Internet and cryptography for mediating disputes and enabling cooperation among suspicious parties, could such instruments dramatically increase capital liquidity, spawning a flood of new wealth in the poorest areas of the world? The Wealth of Poor Nations The poor around the world do, surprisingly enough, have assets. In a simple experiment, in which Hernando de Soto's associates drove about the countryside, assessing the value of buildings which were not formally a part of any formal title registry, de Soto extrapolated that that the value of just the extralegal buildings in the third world amounted to $9.3 trillion: more than the total value of all the publicly traded companies in the world. Moreover, it is not a lack of laws or markets that holds these assets in frozen unusability either. Each village has a clearly understood set of rules about who owns what, and how they may interact and exchange the property they own. A deeper and subtler failure is at work here. There is another brick to be identified and removed. The Brick In the early days of computers, Doug Englebart, who was fascinated with augmentation of the human mind, was asked, what does augmentation mean exactly? What is an example? Realizing that it is very hard to visualize an augmentation until it is already in common use, Doug created an artificially de-augmented system for comparison: he created the pencil with a brick attached to it. When two groups of comparable students were asked to write essays, one group with ordinary pencils, and one group with brick pencils, the quality of the essays written by students with normal pencils was superior to that of the students with bricks. Removing the brick from the pencil, then, is an augmentation. The goal of augmentation, then, is to identify, and remove, the next brick. The Bricks of the 20th Century Difficult as it is to visualize augmentation of the human mind, augmentation of society is perhaps even more difficult to perceive beforehand. Fortunately (or unfortunately, for those who were involved), the 20th Century was in many respects a massive experiment in brick handling. Fascism and Communism, both bricks of monolithic proportions, were tied to societies. On the day the Berlin Wall fell, the per capita ownership of automobiles in the Soviet Union was lower than the per capita ownership of automobiles among blacks under apartheid in South Africa. Comparing these closed societies to the open societies of democratic capitalism,we can see the weight of an enormous brick removed; it is hard to imagine another brick hiding there as well. In fact, there are two other bricks that have been identified, one of which is in the process of being lifted in America as we speak, a brick that takes this nominally open society to an extreme new level of openness. The right of free speech, which underpins so much of the strength of western civilization, is being transformed by the Net. In today's Web-enhanced society, freedom of speech is no longer a right which is to be negotiated between citizen and state; rather, it is a technological fact that accepts no compromise. This new Web-empowered right to free speech is effectively a law, but is completely jurisdiction free--even if all the nations of the world agreed that free speech should be constrained, no constraint would prevail. Technological, Jurisdiction-Free Law The advent of technologically imposed, jurisdiction-free law has several ramifications. Even in the US, where free speech has historically been not merely respected, but rather worshipped, free speech was by common consent constrained. The common example was the duty not to shout "Fire!" in a movie theater, but the enduring example has been copyright law Historically America had a good balance between copyright and free speech. But a technological fact has no ability to compromise: there is no one to negotiate a compromise with. So copyright is destroyed even though it has universal support through all the world's major jurisdictions. Technological facts are morally neutral. why should we in general expect technological laws to be either good or bad? In fact, interaction through the Net is inherently coercionless: no one can point a gun at you through your monitor screen. You could send someone a virus, and under today's law that would be considered a use of force. But sending viruses is also a form of free speech, and under the technological law of the Net, ultimately cannot be compromised. The good news is that computer viruses and large-scale computer cracking is not a technological fact nor a technological law: computer security is possible (ref something about capabilities). Consequently, the correct response to computer viruses is akin to John Stuart Mill's assertion about bad speech: just as the only way to cope with bad speech is with more better speech, so the only way to cope with bad bits (computer viruses) is with better bits (capability secure infrastructures). The First Brick of the 21st Century We have removed so many bricks, how can third world poverty remain as persistently intractable as ever? Free speech is not enough. The end of Communism is not enough. The universal desire for capitalism has proven to be not enough. The naive view held by many people including this author when the Berlin Wall fell was that, once government was out of the way, the market would take care of the people. This has proven tragically wrong. What else is missing, what other bricks must be removed? It seems clear that another brick is the one that distinguishes low-trust from high-trust societies (Fukiyama). Trust relationships directly impact what types of business relationships are possible. It is not so much the absence of direct trust between individual participants that holds a society back, but rather the absence of widely respected trustworthy intermediaries (widely trusted third parties, or WTTPs) that makes business difficult to undertake. It is through these WTTPs that, in advanced societies, strangers can engage in cooperative enterprise. This enables "trust at a distance". However, Western-style WTTP infrastructures are the result of slow growth processes; they build slowly over time. These WTTP institutions can be seen as a form of capital that takes a long time to accumulate. One of the depressing features of the pictures painted by both Fukiyama and de Soto is that the only hope they see for these societies is home-grown, with each individual third world nation bootstrapping itself through all these steps, including the evolution of their own WTTPs. Well, it took a long time for us to do it. If they must do it on their own, it will take them a long time, a time during which desperate poverty will remorselessly prevail. Can we accelerate them through this part of the process of capital formation? Patterns of Trust Trust relationships can be thought of as analogous to the airport hub and spoke pattern (see picture). Many small local networks are interconnected on the wider scale through major hubs. Yet there is not a central hub of hubs that is the top of a hierarchy. Logically, it is peer to peer, but it is built with a backbone architecture due to the economics of the system. In the system of trust relationships, these hubs are the WTTPs. As in the airport analogy, the costs are too high for every airport to have a direct relationship with every other. In the case of trust, the cost is the excessive amounts of information that need to be understood--human beings have the cognitive power to form direct trust relationships with only a very tiny fraction of the number of people in the society; the WTTPs enable us to have indirect trust relationships with virtually everyone. From a simple graph-theoretic point of view, we can analyze the Fukiyama low-trust world (in which the local networks are small) and the de Soto missing-WTTP world (in which the hubs are absent), and immediately recognize which one has the greater impact on a society's effectiveness: it is the absence of the WTTPs that ultimately prevent society-wide trust relationships from forming. Types of Trust Historically, western societies have developed specialized WTTPs that bundle trust with another other expertise: one trusts Citibank not only because Citibank has a demonstrated history of reliably backing their loans, but also because they are experts in loan and risk management, which are necessary elements of reliability in that field: an organization that attempted to engage in banking without expertise in these fields could not be trustworthy no matter how honorable the employees and executives of the organization might be. One broad demarcation of trusted organizations is the distinction between government institutions and private institutions; examples of each category can be seen in Table 1.
The Crucial Trust Specialty In fact, while all these trust institutions are valuable to the construction of advanced societies, not all are equally crucial. de Soto's analysis suggests that the institution which most needs trust, which is most lacking in trust in the third world, are the title agencies. It is through trustworthy title agencies that banks can become confident that the collateral against which they make a loan will indeed become theirs in the event of default. Title registries with this level of reliability enable rights transfer at a distance: people who have never met one another and probably never will can engage in asset transfers and capital formation with the confidence that they will acquire the goods specified in the contract. The Government Solution The obvious--though not necessarily most trustworthy--organization to fill this crucial titling role in a nation is the government itself. This is the strategy de Soto has adopted, converting extra-legal assets, village by village, into officially acknowledged parts of the formal economy. The strategy has been wildly successful by traditional standards of success in bringing the poor into the modern world: over ??? years, de Soto's organization has formalized ??? worth of assets for ???? people, creating ??? amount of capital and ??? of new tax revenues for the governments that have embraced the methodology. But stating that this is a wild success when measured by the traditional standards of success in this endeavor hides as big a truth as it reveals: working through governments is an exhausting, manpower intensive, expensive, slow process. Remarkable as his victory has been, children enter the impoverished third world at a vastly higher rate than the rate at which de Soto is currently lifting them out. Why is this? Though each village has a carefully worked out understanding of the property rights enjoyed by each member of the community, and an understanding of when and how an individual can transfer his assets to another individual within the village, each village's "property law" is idiosyncratic and unique. Attempts by governments to simply discard local traditions about the rules of property are simply ignored: such attempts had been made repeatedly by governments before de Soto, and always ended in futility. de Soto's special insight in this situation has been that the government must respect the local laws, and work out, at considerable cost in time and effort, a way to integrate those local laws with the national systems. As if this work were not difficult enough, this whole process faces enormous obstacles from many different factions, notably bureaucracies and lawyers within the national sphere that see this as an assault on their prerogatives. The process never becomes easy: each village is another major upheaval in the perceptions and preferences of entrenched groups dedicated to protecting the status quo. The Digital Path How can we sidestep this brutally painful process? Perhaps with the Internet. For goods that can be exchanged electronically, the Internet has wiped out geography and jurisdiction. If the function provided by WTTPs can be supplied as a purely electronic service, then the existing first world trust hubs--especially first world title agencies--can bootstrap the third world on a global scale through the new medium. (See Picture). Many first world trust hubs are already trusted in the third world because of the frenetic distribution efforts of the traditional broadcasting media such as television: shows ranging from CNN to Dallas and Baywatch have granted an aura of respectability to first world organizations that most third world governments can only envy. Using first world WTTPs, villages on a global scale can in principle become part of a global trust network. For example, if a person in village A wants to sell a tractor to a person in village D, a couple of villages away, they could in principle use a title registry run by Citibank in New York to execute the transfer. In a similar fashion, the tractor may be securitized, transforming it into capital. And in a state such as Russia, a title listing with Citibank would, ironically, have more legitimacy than a title listed by the government. As an additional bonus, once the villages of the world join this global village, it is much easier to grow the "local" (i.e., national) high-trust hubs as well: an entity becomes high-trust simply by consistently performing in accordance with the contracts being managed by first-world WTTPs. Smart Contracts How would such WTTPs deal with the idiosyncracies of local village tradition, the idiosyncracies that sabotage traditional governmental attempts to capitalize village assets? By the use of smart contracts. In smart contracts, the program code is an operational embodiment of the contract. A drink vending machine is a very primitive example of a smart contract, being executed on a contract host: it is the trusted intermediary between the drink manufacturer and the purchaser. It escrows drinks and money, and performs an exchange of those goods when both have been presented. There is even a rollback process, in which it returns the money if the drink manufacturer is unable to delivery the drink. To the extent possible, the smart contract code directly enforces the terms of the contract; as in the vending machine example, it provides an inescapable arrangement rather than a set of penalty clauses which require separate enforcement after contract breach, as is typical in traditional contracts. (ref Nick Szabo and Ode). The basic metaphor for the composition of smart contracts is the board game. When two people negotiate a contract, they are jointly designing the rules of a game they would both be willing to play. To start the actual play, they turn the board management over to a contract host and start moving assets onto the board, where the contract host escrows the assets for completion. These assets, represented as erights in the electronic context, are the pieces on the board; the players make the moves, but the only moves deemed legal by the code, in the context of the current state of the board, are allowed. In the simple example illustrated in Figure X, we have a 5-party game (contract). Alice wishes to buy stock from Bob. The contract host escrows money from Alice (managed by the currency issuer) and stock from Bob (managed by the stock issuer). Once the money and the stock have both been placed on the board, the contract host transfers title on both assets to the recipients, and the game is over. Games such as this can be arbitrarily sophisticated, requiring only more sophisticated software to embody them. A slightly more sophisticated example is the covered call option. (see figure). One feature of contract hosts that is particularly important in the context of idiosyncratic local village property laws is this: embodying the contract in a smart contract is that the trust is "outsourced" from the specialized contract knowledge needed in traditional WTTPs: The owners of the computer that is acting as a smart contract host do not know, and do not need to know, anything about the nature of the contract. As a consequence, the local village's unique definition of property rights can in principle be embodied in a smart contract, which can be executed with perfect integrity on a WTTP contract server on a different continent, where no one has ever even heard of the village that created this set of property rights. Even the most eccentric of contracts will be executed correctly. This combination, which embodies local knowledge on an outsourced trust platform, could enable the villagers of the third world to leapfrog the enormous homogenization costs of integrating with a national body of law. They would leapfrog into the world of nonjurisdictional coercionless legal systems made possible by the Web. And they can make this jump at Web speeds. Smart Contracting for the First World Smart Contracting is not just a good idea for the third world. In technological western civilization as well, smart contracts can wring new efficiencies from the economy. An example can be seen in the way a new special-purpose contract host was able to change the dynamics of the videotape rental industry in the 90s: When videotape rental first emerged as a business, movie producers charged the rental stores extremely high prices for movies. The rental stores inevitably responded by buying as small a number of copies of each movie as they could, and reusing those tapes as long as they dared. The consequence for the consumer was that videos of newly-released movies were scarce, and the videos of long-released movies were in poor condition. How did we get to the current state of affairs, in which BlockBuster routinely guarantees availability of brand new movies? By bringing out a new cash register: a cash register that automatically tracked a per-rental fee and transmitted it to the studio. With these cash registers acting as trusted third party contract hosts, the rental stores were able to persuade the producers to change their pricing model. Since the actual manufacture of the video tape was inexpensive, and since the studios were confident that their cut each transaction was protected, the studios began giving the rental stores movies at nominal prices, encouraging the rental stores to maintain quantity and quality at dramatically higher levels. The Rule of Law, Not Of Men What does smart contracting do to the next brick? The next brick that must be removed from the world is the brick that prevents the long-distance credible right of property transfer. We remove this brick by moving the village to Cyberspace: placing the local village on the Internet, adjacent to the globally recognized WTTPs already present there, and enabling the implementation of smart contracts filled with local knowledge on an impartial contract host continents away. Once this transition takes place, we will see that jurisdiction-based law, even when nation-wide, is crippled in the same way that village-wide law is crippled. The third world will then ironically lead the first world into a brighter place with fewer bricks than society has ever had before. Just as in phone systems, if you have no land line system, you are more likely to leap over such infrastructure development and go directly to cell phones, so too is the third world more likely to leap across national jurisdictional systems, and go directly to the high-efficiency, low friction, strongly impartial, extremely corruption-resistant, non-jurisdictional legal systems of the future. It will bring us a giant step closer to a world governed by the rule of law, not of men |
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