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- <P ALIGN="RIGHT"><FONT SIZE="7"><!-- #BeginEditable "BigTitle" --><FONT SIZE="7"><B>The
+ <P ALIGN="RIGHT"><FONT SIZE="7"><!-- #BeginEditable "BigTitle" -->The
Digital Path:<font size="5"><br>
Smart Contracts and the Third World<br>
- </font> <br>
- <font size="4">by Mark S. Miller and Marc Stiegler</font></B></FONT><!-- #EndEditable --></FONT>
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+ <font size="4">by Mark S. Miller and Marc Stiegler</font></font><!-- #EndEditable --></FONT>
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+ <p align="center"><i>Draft paper to be submitted to "<a href="http://panoramix.univ-paris1.fr/AHTEA/colloques.html">Austrian
+ Perspective on the New Economy</a>".<br>
+ Please comment.</i></p>
+ <h3>Abstract</h3>
+ <p><font color="#FF0000">*** To be written</font></p>
+ <h3><a name="intro"></a>Introduction</h3>
+ <p>As Hernando de Soto explains in <i>The Mystery of Capital</i> [<a href="#deSoto00">deSoto00</a>],
+ the poor of the third world (including much of the former communist world)
+ do not suffer from, in his terminology, a lack of <i>assets</i>; rather,
+ they suffer from a lack of <i>capital</i>. Many of the poor around the
+ world do, surprisingly enough, have assets. In a simple exercise, in which
+ de Soto's associates drove around neighborhoods in various poor countries,
+ assessing the value of buildings which were not formally titled, de Soto
+ extrapolated that the value of just the informally owned buildings in
+ the third world amounted to $9.3 trillion -- more than half the combined
+ value of all publicly traded U.S. companies.</p>
+ <p>De Soto's focus is on the <i>informal</i> sector -- that sphere of economic
+ activity that occurs outside the official <i>formal</i> legal system.
+ Most of the economic activity of the third world's poor occurs in the
+ informal sector. Despite the non-official status of the informal systems
+ of laws and property in this sector, they are nevertheless quite real,
+ and form the foundations on which these informal economies function. However,
+ the formal and informal sectors are not otherwise equivalent. The poor
+ pay a great price for informality -- most of all in the difficulty of
+ capital formation.</p>
+ <p>As a simple example, the house you live in, from which no one would attempt
+ to evict you, is an asset. The recognition and sense of legitimacy in
+ your local community of your claim to the house makes this asset effectively
+ your property. A mortgage on that house would be capital. (In the countries
+ that have become rich, mortgages in particular have been a major source
+ of highly decentralized investment, seeding many family businesses.) But
+ just because no one can evict you from your house, this does not mean
+ a bank dares accept it as collateral for a loan. The distinction is one
+ of <i>credibility of property rights transfer at a distance</i>, i.e.,
+ the ability to engage in binding contracts such that the new owners could
+ be confident they could indeed evict you as part of the contract, despite
+ their distance from your community.</p>
+ <p>De Soto's offer of hope for the poor is to transition into today's official
+ formal system of law and property, backed by national governments, in
+ order to obtain the benefits of capital formation. De Soto documents well
+ both the high comparative costs of operating formally, and the difficulties
+ of bringing about the transition, but successfully makes the case that
+ the benefits outweigh the costs. Today, there are only these two choices
+ -- the informal path <i>vs.</i> governmental path. Given only these choices,
+ we believe de Soto is advocating the right one, we wish him great luck
+ with his program, and we do not wish to distract those who are able to
+ make this transition successfully. Indeed, we can imagine few more effective
+ programs for improving the overall condition of humanity.</p>
+ <p>Despite our admiration, this paper takes a different approach; it explores
+ a third path, a possibility openned up by the new technologies of the
+ Net, cryptography, and <i>capability-secure </i>platforms -- languages
+ [<a href="#Hewitt73">Hewitt73</a>, <a href="#Tribble95">Tribble95</a>,
+ <a href="#Rees96">Rees96</a>, <a href="#Miller00">Miller00</a>] and operating
+ systems [<a href="#Hardy85">Hardy85</a>, <a href="#Shapiro99">Shapiro99</a>]
+ able to run hostile code safely <i>and flexibly</i>. (Given the exponential
+ rate at which the cost of electronics and wireless communications are
+ falling, the cost of the technology itself should rapidly become a non-issue,
+ even for the world's poorest.) Because binding contracts for ownership
+ transfer lie at the heart of capital formation, What if traditional contracts
+ were supplemented and/or supplanted with <i>smart contracts</i>? Smart
+ contracts are contracts-as-program-code, in which the terms of the contract
+ are enforced by the logic of the program's execution. Smart contracts
+ will enable cooperation among mutually suspicious parties, often without
+ need for legal recourse. Could such a jurisdiction-free contracting mechanism,
+ accessible over the net, dramatically increase capital liquidity, spawning
+ a flood of new wealth in the poorest areas of the world? </p>
+ <h3><a name="nohubs"></a>Networks of Trust</h3>
+ <p>Why are some societies so much better able to generate wealth than others?
+ During the great oppressions of the twentieth century, many people, including
+ the authors this paper, held the naive view that once oppression was out
+ of the way, market would bloom and take care of the people. This has proven
+ tragically wrong. The years since then have shown that the absence of
+ oppression was not enough. Free speech was not enough. The end of socialism
+ was not enough. The universal desire for capitalism was not enough. In
+ order to successfully help, we must first solve this riddle. Many people
+ have tried, and the answers proposed by Hernando de Soto and Francis Fukuyama
+ are especially insightful and complementary.</p>
+ <p>Fukuyama's <i>Trust</i> [<a href="#Fukuyama95">Fukuyama95</a>] makes
+ many perceptive observationsof how the world's <i>cultures</i> differ
+ regarding attitudes and proclivities towards trust -- how easily, and
+ under what conditions, members of a particular culture come to trust each
+ other. In the <i>high trust </i> societies, mutually trusting relationships
+ are easily formed. In <i>low trust </i>societies they are not. In Fukuyama's
+ taxonomy, the third major category, <i>familial trust </i>societies (or
+ confucian societies), is not between the other two on a spectrum. Rather,
+ it is a different stable pattern characterized by dense networks of high
+ trust within families, but rather low trust between families. Fukuyama
+ shows how these different patterns of trust seem to explain some of the
+ observed differences in the patterns of businesses that arise in these
+ cultures. Complex cooperative arrangements require trust, so not surprisingly,
+ Fukuyama's high trust societies are the ones able to generate vast amounts
+ of wealth.</p>
+ <p>But to understand the success of the first world requires something more
+ than Fukuyama's analysis. No matter what the culture, simple cognitive
+ limitations prevent any of us from knowing, much less trusting, more than
+ a very small fraction of the members of our societies. Nevertheless, in
+ the first world massive numbers of strangers meet, trade, do business,
+ negotiate, and sign contracts, despite lack of any prior knowledge of,
+ or reasons to trust in, each other. How is this possible?</p>
+ <p></p>
+ <p>De Soto's earlier book, <i>The Other Path</i> [<a href="#deSoto89">deSoto89</a>],
+ tells a complementary story. De Soto can also be understood as explaining
+ differences in economic organization according to differences in the possibilities
+ for trust. However, de Soto's emphasis is not culture but institutions,
+ and their lack. De Soto's portrayal of the poor within a the third world
+ village is not one of culturally-based low trust. Rather, it is the painful
+ lack of the various widely trusted intermediate institutions (or WTIIs)
+ that catalyze commerce at a distance in the first world, and that we normally
+ take for granted.</p>
+ <p><b><img src="images/1-hubs.gif" width="347" height="212" align="right"></b>Trust
+ relationships can be thought of as analogous to the airport hub and spoke
+ pattern. (Figure 1). Many small local networks are interconnected on a
+ wider scale through major hubs. Although this pattern is a partial centralization,
+ it is not a hierarchy -- there is, for example, no central hub of hubs.
+ Logically, it is peer to peer, but it is built with a backbone architecture
+ due to the economics of the system. The Net itself has mostly the same
+ architecture, as does the highway system. In all cases, a sparsely connected
+ actual network acts for most purposes like a densely connected network.
+ For example, from any airport you can fly to any other airport, almost
+ as if there were flights between every pair of airports.</p>
+ <p>Similarly, in the first world, two strangers can meet and conduct business
+ as if they had prior knowledge of and trust in each other, by virtue of
+ their reliance on a mutually recognizing backbone of WTIIs. These WTIIs
+ are both in the business of securing these relationships to minimize the
+ risks their customers face from each other, sometimes requiring it to
+ absorb some of these risk onto itself. The economies of scale available
+ to a WTII can help tremendously with these risks. Historically, western
+ societies have developed specialized WTIIs that bundle trust with 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.</p>
+ <p>Other examples of familiar WTIIs include title companies, insurance,
+ escrow, exchanges and auction houses, underwriters, Consumer Reports,
+ Roger Ebert, notaries, arbiters, courts and cops, money, etc... The list
+ is endless. </p>
+ <p><img src="images/2-low-trust.gif" width="350" height="218" align="right">From
+ a simple graph-theoretic point of view [<a href="#Granovetter73">Granovetter73</a>],
+ we can analyze the Fukiyama low-trust world (in which the fanout from
+ each node is small) and the de Soto missing-WTII world (in which the hubs
+ are absent), and immediately recognize which effect has the greater impact
+ on a society's effectiveness: it is the absence of the WTIIs that ultimately
+ prevent society-wide trust relationships from forming. Even with high
+ cultural proclivity for individual-to-individual trust, in the absence
+ of hubs, the resulting virtual network would at best form small islands
+ of densely connected networks, only loosely connected to each other. The
+ resulting picture resembles both Fukuyama's portrayal of familial trust
+ societies, and de Soto's portrayal of networks of villages of informals.</p>
+ <div align="center">
+ <table cellpadding="12">
+ <tr>
+ <td>
+ <p align="center"><i>The division of labor is limited by the extent
+ of the market.</i></p>
+ <p align="right">--Adam Smith</p>
+ </td>
+ </tr>
+ </table>
+ </div>
+ <p>The virtual network of Figure 1 forms one large market with great extent,
+ enabling a great division of knowledge and labor. The virtual network
+ of Figure 2 is one of many separate markets, barely connected to each
+ other, and each individually of minor extent.</p>
+ <p>But shouldn't this situation be an ideal growth medium for WTIIs? If
+ there is great market need for them, then surely there is great demand
+ and great opportunity. Indeed, this is the situation from which the WTII
+ backbone grew spontaneously in the west. Absent government oppression
+ we should indeed expect it to grow here as well. However, Western-style
+ WTII infrastructures are the result of slow growth processes; they build
+ slowly over time. These widespread trust needed by these institutions
+ can be seen as a form of capital that takes a long time to accumulate.
+ </p>
+ <p>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 WTIIs; or the reform
+ and transformation of each society's national government into a system
+ of widely trusted institutions. Well, it took a long time for the west.
+ If they must recapitulate our path, it will take them a long time as well,
+ a time during which desperate poverty will remorselessly prevail. What
+ enablers are available now that were unavailable when the west made this
+ transition? Might these enablers be used to help accelerate today's poor
+ through this part of the process of capital formation?</p>
+ <h3><a name="title"></a>The Special Roles of Title and Law</h3>
+ <p>In <i>The Other Path</i>, de Soto explained the informal economy and
+ its lack of institutions in general. Eleven years later, after much investigation
+ both of the phenomenon of persistent poverty, and an extraordinary uncovering
+ of the history of how the west overcame these problems, in <i>The Mystery
+ of Capital</i> de Soto has narrowed his focus to the crucial role played
+ by the institution of title.</p>
+ <p>While all these WTIIs are valuable for the fomation of wealth creating
+ societies, not all are equally crucial. De Soto's analysis suggests that
+ the institution most needed to get the ball rolling, and which are most
+ painfully absent in the informal sectors of the third world, are credible
+ systems of title transfer. It is through widely trusted 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. This requires
+ not just trust in the title company itself, but credibility that a transfer
+ of title on the books will be honored as a transfer of ownership in reality.
+ Title registries with this level of credibility enable <i>rights transfer
+ at a distance</i>: 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.</p>
+ <p>Although de Soto documents the independent creation of title companies
+ in the informal sector, these do not currently seem to be able to provide
+ the credibility at a distance needed for this transition.</p>
+ <h3><a name="govt"></a>The Governmental Paths</h3>
+ <p>Among currently existing choices, perhaps the only organization that
+ can 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 in bringing the poor into the
+ modern world. Working with the government of Peru, over four years, de
+ Soto's organization has formalized ??? worth of assets for a quarter of
+ a million people, creating ??? amount of capital and $2.1 billion of new
+ tax revenues for the government of Peru. One may hope and expect that
+ these demonstrated tax revenues, if nothing else, will tempt other governments
+ to follow suit.</p>
+ <p>De Soto's isn't the first attempt to title the informal's property and
+ bring them into the formal sector, but it is the first such attempt in
+ the third world to work. De Soto documents previous well intentioned efforts,
+ with surveyors, geographic information systems, interviews of informals
+ to ascertain who owns what, and formal title registries backed by the
+ formal legal system -- all the obviously necessary ingredients. Why did
+ these previous attempts all fail? </p>
+ <p>Because the formals did not appreciate that the informals already had
+ worked out system of law, rights, and obligations, negotiated over time
+ and idiosyncratic village by village -- <i>the people's law</i>. Instead,
+ the formals approach to the situation was <i>We have a legal system. You
+ don't. Here's ours. </i>Although the title listings reflected a snapshot
+ of who-owns-what, the legal system governing these title listing did nothing
+ to reflect the complex negotiated informal arrangements needed to understand
+ what rights someone actually held to a particular asset. Given this mismatch,
+ the informals proceeded to ignore the formal title registries and trade
+ assets in the way they always had. The title registries were not updated
+ to reflect changes of actual ownership, and so rapidly became even more
+ irrelevant. De Soto's special insight in this situation has been that
+ the government must discover and 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.</p>
+ <h3><a name="conflict"></a>Local Knowledge <i>vs. </i>Global Transferability</h3>
+ <p> The difficulty comes from an inherent conflict between <i>local knowledge</i>
+ and <i>global transferability</i> -- local knowledge of the idiosyncratic
+ people's law, conventions, and negotiated arrangements in force in each
+ village, <i>vs.</i> the need to move the governance of title transfer
+ to WTIIs, whose wide scope requires them to operate from a more homogenized
+ set of rules. This tension is acute on the governmental path, as the homogenized
+ set of rules is not even per title company, but rather the official legal
+ system itself. Governmental legal systems are hardly the wonders of adaptability
+ de Soto's program would seem to require. Even with the best of intentions,
+ an accommodation between the two must rapidly turn into a Procrustean
+ bed. However, de Soto offers no alternative. Though difficult, he is successfully
+ making this path work, and he documents how it did work when formal U.S.
+ law, slowly and painfully, absorbed the informal wild west.</p>
+ <p>As if this path 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,
+ as de Soto also documents. The process never becomes easy: each step of
+ progress is another major upheaval in the perceptions and preferences
+ of entrenched groups dedicated to protecting the status quo.</p>
+ <h3><a name="bootstrapping"></a>The Digital Path</h3>
+ <div align="center">
+ <table cellpadding="12">
+ <tr>
+ <td>
+ <p align="center"><i>National borders aren't even speed bumps on
+ the information superhighway.</i></p>
+ <p align="right"><i>--Tim May</i></p>
+ </td>
+ </tr>
+ </table>
+ </div>
+ <p>Can we sidestep this brutally painful process? Perhaps eventually with
+ the Net. </p>
+ <p><font color="#000000"><img src="images/3-bootstrap.gif" width="366" height="214" align="right">Due
+ to the Net, purely electronic goods and services can now be purchased
+ from across the world as easily as from next door. Consumers of these
+ goods and services have already escaped old limits of geography and jurisdiction.
+ If the functions provided by various WTIIs were offered by prominent first
+ world trust hubs as purely electronic services, those in need of such
+ widely trusted intermediary services could escape as well -- escape from
+ the crushing assumption that such services can only be provided by institutions
+ beholden to their own governments. Instead, they could reach across the
+ Net to use these services, and begin to bootstrap themselves out of their
+ poverty by participating in the global networks of commerce. (Figure 3)
+ </font></p>
+ <p>Many first world trust hubs are already widely known and plausibly trusted
+ in the third world because of the frenetic distribution efforts of western
+ media: shows ranging from CNN to Dallas and Baywatch have granted an aura
+ of respectability to first world organizations that most governments can
+ only envy. (However one may feel about this process, it is occurring,
+ so we may as well put it to good use.) Using first world WTIIs, villages
+ on a global scale could 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 easily 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 because the titling institution is beyond the reach
+ of their own government.</p>
+ <p>O<font color="#000000">nce the villages of the world join this global
+ village, it will be much easier for them to grow jurisdiction-free high-trust
+ hubs as well: an entity becomes widely trusted by consistently and visibly
+ performing in accordance with various contracts -- contracts being managed
+ by hubs that are already widely trusted. With a working trust backbone,
+ highly trustworthy behavior gets the visibility it needs to more rapidly
+ accumulate its own reputation-capital. </font></p>
+ <h3><font color="#000000"><a name="smart-contracts"></a>Smart Contracts</font></h3>
+ <p>How might such WTIIs deal with the idiosyncracies of each village's <i>people's
+ law</i>, the idiosyncracies that sabotage traditional governmental attempts
+ to capitalize village assets, without taking on the impossible burden
+ of learning all this local knowledge itself, without imposing the costs
+ of homogenization? By the use of smart contracts.</p>
+ <p><font color="#000000">In smart contracts, the program code is an operational
+ embodiment of the contract [<a href="#Szabo97">Szabo97</a>]. A drink vending
+ machine is a very primitive example of a smart contract, being executed
+ on a contract host: it is the partially 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
+ cannot be delivered. Traditional contracts are understood to be backed
+ by a coercive enforcement system made of courts and cops. However, the
+ vending machine does not have the option of such recourse following a
+ breach. In what sense is it a contract?</font></p>
+ <p>The vending-machine-as-contract would indeed require separate enforcement
+ if it dispensed the drink first and then demanded payment. However, by
+ escrowing both drinks and payment before dispensing either, it also dispenses
+ with the need for separate enfocement. Instead of enforcement, the contract
+ creates an <i>inescapable arrangement</i>. It cannot prevent the customer
+ from walking away before the game is over, but a customer who walks away
+ from a contract in progress leaves behind any assets escrowed by the contract
+ at that point [<font color="#000000"><a href="#Miller00">Miller00</a>]</font>.
+ The terms of the contract are enforced by the contract itself -- by the
+ behavior of the contract when executed as a program.</p>
+ <p>Although conventional coercive recourse is still often possible on the
+ Net, for more and more Net commerce these costs are too great, and the
+ jurisdictional issues potentially too messy. Instead, Net businesses have
+ been engaging in rich and rapid experimentation with cooperative arrangements
+ that require no coercive recourse [<a href="#Krecke01">Krecke01</a>].
+ The most common arrangements involve not actual escrow, but reputation
+ feedback and credit [<a href="#Steckbeck01">Steckbeck01</a>]. This has
+ a similar logic, in that a partcipant effectively secures their good performance
+ with the value of their reputation capital. Such arragements are messier
+ and less amenable to automation than escrow, but they do substantially
+ reduce capital costs. Both kinds of arrangements have their place and
+ will compete in the market. Here, I will explore escrow-based smart contracts,
+ not because I expect this form to dominate, but because their logic is
+ vastly easier to explain; because they're easier to build, and so will
+ occur sooner; and because they apply to participants with no prior reputation,
+ which helps for bootstrapping the transition. Likewise, for the electronic
+ systems of title (or <i>issuers</i> below), in this paper I assume systems
+ that provide for instant settlement [<a href="#e-gold">e-gold</a>]. Although
+ delayed settlement may substantially reduce capital costs [<a href="#Selgin01" target="_top">Selgin01</a>],
+ they turn smart contracts into explosions of complexity.</p>
+ <h3><font color="#000000"><img src="images/4-exchange.gif" width="390" height="266" align="right"></font>Contracts
+ as Games</h3>
+ <p><font color="#000000">A basic metaphor for 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. Once they commit
+ to playing this game, the players may then make moves, but only moves
+ judged legal by the rules given the current board state. Each move potentially
+ changes the board state, changing which moves are legal during the next
+ turn.</font></p>
+ <p><font color="#000000">For example, Figure 4 shows the six possible board
+ states of a simple negotiation and exchange game. Let's say Alice is playing
+ the left side of the board and Bob the right. The initial board state
+ is the one shown on the far left, in which neither of the pieces is on
+ the board. The gold bar, representing money, is off the board on the left,
+ which portrays its possession by Alice at this time. For concreteness,
+ let's say the knight represents stock. Bob might offer a certain amount
+ of stock to Alice by placing it on the right square of the board. This
+ takes us to the board state that's up and right from the initial state.
+ Alice might not respond soon enough, in which case Bob may withdraw his
+ offer by taking back the knight, bringing us back to the initial state.
+ That's why the first transition arrow is shown as bidirectional.</font></p>
+ <p><font color="#000000">Or Alice may respond to Bob's offer with a certain
+ amount of money, by placing it on the left square of the board. This takes
+ us to the upper right board state. At this point, either party may still
+ decide they're unsatisfied, withdraw their piece, and reenter the loop
+ of bidirectional arrows. Or, in the upper right board state, Bob may pick
+ up the money offered by Alice. Bob has accepted Alice's offer. This is
+ the irreversible commitment step shown by the bold unidirectional arrow,
+ and takes us to the board state down one. From here, the only possible
+ move is for Alice to pick up Bob's knight.</font></p>
+ <p>How is this contract self enforcing? What prevents cheating? Who needs
+ to trust whom with what? To answer these questions, we must start by explaining
+ what is happening on whose computer. We assume that each player trusts
+ their own computer (a dangerous assumption, but we cannot proceed without
+ it). We also assume that player A cannot not trust player B's computer
+ any more or less than they trust player B. Under these assumptions, we
+ can treat a computer and its proprietor as a single unit for purposes
+ of analysis.</p>
+ <p><font color="#000000"><img src="images/5-duties.gif" width="297" height="299" align="right">The
+ execution of this game actually involves five parties, as illustrated
+ in Figure 5. The two players of course, Alice and Bob. The contract host
+ serves the same role as our vending machine -- it is the third party mutually
+ trusted to execute the contract/program faithfully. The contract can be
+ any program Alice and Bob mutually agree on, written in a safe language
+ suitable for writing smart contracts, that functions as the <i>board manager</i>
+ for the game they have agreed to play. (A <i>board manager</i> for, for
+ example, chess, is a program that enables two people to play with each
+ other, maintains the board state, and only allows legal moves. A board
+ manager does not itself play the game.)</font></p>
+ <p><font color="#000000">Unlike the vending machine, the contract host need
+ not have any prior knowledge of the contract.</font> Once Alice and Bob
+ agree on the text of a board manager and on a mutually trusted contract
+ host, they upload the board manager to the contract host, which then verifies
+ for them that they've agreed on the same contract, and dispenses to each
+ the right to play their respective sides of the game, shown as the arrows
+ pointing at the respective chairs. The contract can embody the knowledge
+ of acceptable arrangements local to Alice and Bob, local custom, prior
+ handshakes, etc... If the contract host can be trusted at all, it can
+ be trusted to run this contract faithfully, despite its ignorance of the
+ local knowledge that gives this contract meaning. The tension between
+ local knowledge and widespread trust is partially resolved.</p>
+ <p>(In the vast majority of cases, one would expect Alice and Bob to select
+ a "boilerplate" contract/program off the shelf and fill in the
+ blanks, rather than write a contract/program from scratch. However, the
+ story of the custom contract better shows the logic by which the system
+ operates, and may explain how these shelves will come to be stocked.)</p>
+ <p>The "$-Issuer" and the "Stock-Issuer" turns the movement
+ of the pieces into a transfer of erights. A $-Issuer, or more conventionally
+ a bank, is effectively a title company for money. For money on record
+ at the bank, the rights to the money changes hands by the transfer of
+ quantity between accounts -- shown above as <i>purses</i> within the issuers.
+ When Alice places the gold bar on the board, her computer, the $-Issuer,
+ and the contract host engage in a three-way cryptographic transaction
+ that bring about the transfer of title, at the $-Issuer, of that much
+ money from Alice to the contract host. An honest contract host would consider
+ this money to be only a piece on the board, which can be picked up (transfered
+ to the possession of a player) according to whatever may be the rules
+ of the game. We refer to this as <i>oblivious escrow</i>.</p>
+ <p>A dishonest contract host could abscond with the money instead, which
+ is why contract hosts needs to be widely trusted. A widely trusted contract
+ host presumably has a valuable reputation at stake, and this risk helps
+ secure honest behavior. (More sophisticated cryptographic protocols are
+ possible which further limit the player's vulnerability to a dishonest
+ contract host or issuer, but these are beyond the scope of this paper.)
+ </p>
+ <p>In the arrangement shown here, the $-Issuer, the Stock-Issuer, and the
+ contract host need not have any prior knowledge or trust of any of the
+ other four players. For the game to be meaningful, Alice and Bob must
+ have prior knowledge and trust in both issuers and the contract host,
+ but not in each other. Even if Alice and Bob are both use-once pseudonymous
+ identities with no apparent physical location [<a href="#Vinge84">Vinge84</a>],
+ under these conditions, they can transact with each other <i>as if</i>
+ they fully trust each other.</p>
+ <h3>Assets + Contracts x Time = Capital</h3>
+ <p><font color="#000000"><img src="images/6-option.gif" width="379" height="235" align="right">The
+ Smart Contracts explained so far, the vending machine and the exchange
+ game, cannot turn assets into capital. To do so requires contracts that
+ unfold over time, like a mortgage. To explain how such unfolding creates
+ ever more abstract forms of property, a good clear example is the <i>covered
+ call option</i>. (Such instruments are kindergarden finance for many,
+ so excuse us while we belabor the obvious. Re-explaining the familiar
+ is often necessary when translating into a different medium.)</font></p>
+ <p><font color="#000000">Alice has an <i>option</i> when she has the right,
+ but not the obligation, to engage in some action at some agreed price
+ before some deadline. Alice has a <i>call</i> option when she has the
+ right to buy some agreed asset, let's say stock, at some agreed price
+ before the deadline. The option is a <i>covered</i> call option when Alice's
+ counterparty, Bob, escrows up front the stock Alice may decide to purchase.</font></p>
+ <p>We may visualize this as the game shown in Figure 6. In the initial board
+ state, shown in the top left, the stock is already on the board. While
+ in this state, neither Alice nor Bob may pick up the stock. Another "player"
+ in the game, so to speak, is the game clock. Should the deadline expire
+ while in this initial state, the clock causes a transition to a state
+ from which Bob can now pick up his stock and go home.</p>
+ <p>Or, before the deadline expires, Alice may decide to <i>exercise</i>
+ the option. She may place a gold piece on the left square. Unlike in the
+ previous game, in this game the acceptable amounts are predetermined by
+ the rules. The left square only accepts a certain amount of money. If
+ Alice places this amount of money on the board, this is the irrevocable
+ commitment step shown as the bold unidirectional arrow. After this move,
+ the only remaining legal moves are for Alice to pick up the stock, and
+ for Bob to pick up the money.</p>
+ <p>What is so different about this contract? During the time between when
+ the game starts (when Alice gets access to her chair) and the time when
+ the game transitions to a new board state (either by expiration of the
+ deadline or by exercise of the option), Alice a something valuable. During
+ this interval, Alice has the option to buy this stock. This is a very
+ different kind of value to have than the stock or money themselves. The
+ value of this new right <i>derives</i> from the value of the stock and
+ the money, but whereas they are very simple literal kinds of rights, this
+ new right is somehow more abstract. In Wall Street terminology, the new
+ right is a <i>derivative</i> of the more literal <i>underlying</i> rights.
+ In de Soto's terminology, if the literal instruments are physical <i>assets</i>,
+ then abstract rights derived by contracts about these instruments are
+ <i>capital</i>. </p>
+ <p>But there's something missing from this picture. Through the system so
+ far depicted, Alice can trade those rights managed by issuers -- money
+ and stock. The contract host, despite its complete ignorance that it has
+ done so, has created a new valuable right, owned by Alice. But in the
+ picture so far, Alice has no ability to trade this new right. This needs
+ to be repaired, in order for these new rights to truly be capital, and
+ in order for yet more abstract forms of capital to be derived from them.</p>
+ <h3><img src="images/7-layering.gif" width="308" height="304" align="right">Networks
+ of Games</h3>
+ <p>What we need, quite simply, is an issuer of this new right Alice holds
+ -- the right to sit in the left chair, in order to be able to play the
+ left side of this on-going game. Since the contract host is already managing
+ access to this chair, it seems natural to have it double as the issuer
+ for the right to sit in this chair. Just as Alice could tell the $-Issuer
+ to transfer some of her money from her purse to some else's, we can enable
+ Alice to tell the contract host to transfer her right to sit in this chair
+ to someone else. The contract host would then revoke Alice's access to
+ the chair, and issue fresh access to the new player, much as the $-Issuer
+ does with Alice's money.</p>
+ <p>With this ability to compose networks of games, it seems we have the
+ ability to express the full range of contract layering used in modern
+ finance. Not that modern finance is directly relevant to the needs of
+ the poor, but it is a good test of the generality of our framework.</p>
+ <p>But wait. This structure decouples knowledge in a way quite different
+ than anything in the financial world. We have the contract host issuing
+ rights it does not understand, since these rights are produced by games
+ it runs, but does not understand. The contract host is not in a position
+ to vouch for any meaningful property of the rights it is issuing, so how
+ can widespread trust in the contract host translate into credible global
+ transferability of derived rights? Let's walk through the example depicted
+ in Figure 7.</p>
+ <p>Alice starts out simply as a player of the original options game, hosted
+ by contract host #1. While Alice finds herself in the resulting valuable
+ situation, she manages to find Fred, who would also find this position
+ valuable. Fred, were he convinced that Alice's chair sitting rights mean
+ what Alice says they mean, would be willing to play a game on contract
+ host #3 in which this right, issued by contract host #1, appears as a
+ movable piece. Unfortunately, having just met, Fred and Alice don't trust
+ each any more than Alice and Bob do. Fortunately, Fred does have prior
+ knowledge and trust of contract host #1. Unfortunately, contract host
+ #1 has no idea if the right to sit in this chair of this game means what
+ Alice claims it means, or anything else. </p>
+ <p>Fortunately, with Alice's consent, Fred can ask contract host #1 for
+ the text of the contract/program and the current state of the board. In
+ theory, this should be sufficient for Fred to figure out what these derived
+ rights are. Alice, who presumably understands the game she's playing,
+ can help Fred figure this out, and Fred can accept this help, with any
+ trust required between Fred and Alice. Should the contract truly be idiosyncratic
+ to local knowledge shared by Alice and Bob, knowledge to which Fred has
+ no access, he may not find the derived rights comprehensible at reasonable
+ cost and move on. More commonly, if the contract is understandable to
+ some number of others, including some Fred trusts, Fred may turn to them
+ for advice on the contract's meaning -- the computational analog of legal
+ advice.</p>
+ <h3>Local Knowledge <i>and</i> Global Transferability</h3>
+ <p><font color="#FF0000">*** to be written</font></p>
+ <h3>The World isn't Purely Electronic</h3>
+ <table cellpadding="12">
+ <tr>
+ <th>
+ <div align="left"></div>
+ </th>
+ <th>
+ <div align="left">Pubic eTitle in physical goods<br>
+ (tractor, land)</div>
+ </th>
+ <th>
+ <p align="left">Purely electronic rights<br>
+ (money, stock)</p>
+ </th>
+ </tr>
+ <tr>
+ <th>
+ <div align="left">Informal:<br>
+ local consensus</div>
+ </th>
+ <td>
+ <div align="left">Can eTitle establist popular legitimacy?</div>
+ </td>
+ <td>
+ <div align="left"></div>
+ </td>
+ </tr>
+ <tr>
+ <th>
+ <div align="left">Jurisdictional:<br>
+ public records<br>
+ lawyers, cops</div>
+ </th>
+ <td>
+ <div align="left">Incentives on corrupt courts</div>
+ </td>
+ <td>
+ <p align="left">Behavior as 9/10th of law.</p>
+ <p align="left">Split contracts</p>
+ </td>
+ </tr>
+ <tr>
+ <th>
+ <div align="left">Digital Path:<br>
+ Jurisdiction-free<br>
+ Coercionless </div>
+ </th>
+ <td>
+ <div align="left">Incentives on corrupt cops</div>
+ </td>
+ <td>
+ <div align="left">10/10th of law</div>
+ </td>
+ </tr>
+ </table>
+ <h3> </h3>
+ <p> </p>
+ <h3>The Rule of Law, Not of Men</h3>
+ <p><font color="#FF0000">*** to be written</font></p>
+ <h3><a name="acks"></a>Acknowledgements</h3>
+ <p>These ideas have formed over much time and many valuable conversations,
+ for which we thank K. Eric Drexler, Charles Evans, Ian Grigg, Robin Hanson,
+ Doug Jackson, Don Lavoie, Zooko (Bryce Wilcox-O'Hearn), Gayle Pergamit,
+ Chris Peterson, Terry Stanley, Nick Szabo, E-Dean Tribble, Bill Tulloh,
+ Ka-Ping Yee, and the members of the e-lang mailing list.</p>
+ <h3><a name="refs"></a>References</h3>
+ <p><a name="Bartley62"></a>[Bartley62] William W. Bartley, III, <i><b>The
+ Retreat to Commitment</b> </i>Open Court Publishing, 1962.</p>
+ <p><a name="Birch"></a>[Birch] Greg Birch, personal communication.</p>
+ <p><a name="deSoto89"></a>[deSoto89] Hernando de Soto, "<b>The Other
+ Path</b>", Harper & Row, 1989.</p>
+ <p><a name="deSoto00"></a>[deSoto00] Hernando de Soto, "<b>The Mystery
+ of Capital</b>", Basic Books, 2000. Chapter 1 online at <a href="http://www.ild.org.pe/tmoc/language.htm">http://www.ild.org.pe/tmoc/language.htm</a>.</p>
+ <p><a name="e-gold"></a>[e-gold] See <a href="http://www.e-gold.com/e-gold.asp?cid=101791">http://www.e-gold.com/e-gold.asp?cid=101791</a>.</p>
+ <p><a name="Engelbart62"></a>[Engelbart62] Doug Engelbart "<b>Augmenting
+ Human Intellect: A Conceptual Framework</b>", SRI Project no. 3578,
+ October 1962.</p>
+ <p><a name="Fukuyama95"></a>[Fukuyama95] Francis Fukuyama, "<b>Trust</b>",
+ Free Press Paperbacks, 1995. </p>
+ <p><a name="Granovetter73"></a>[Granovetter73] Mark Granovetter, "<b>The
+ Strength of Weak Ties</b>", in: American Journal of Sociology (1973)
+ Vol. 78, pp.1360-1380.</p>
+ <p><a name="Hardy85"></a>[Hardy85] Norm Hardy, "<b>The KeyKOS Architecture</b>",
+ Operating Systems Review, September 1985, pp. 8-25. Updated at <a href="http://www.cis.upenn.edu/%7EKeyKOS/OSRpaper.html">http://www.cis.upenn.edu/~KeyKOS/OSRpaper.html</a>.</p>
+ <p><a name="Hardy99"></a>[Hardy99] Norm Hardy, "<b>Computer Security,
+ the Very Idea</b>". Online at <a href="http://www.cap-lore.com/Dual.html">http://www.cap-lore.com/Dual.html</a>.</p>
+ <p><a name="Hewitt73"></a>[Hewitt73] Carl Hewitt, Peter Bishop, Richard
+ Stieger, "<b>A Universal Modular Actor Formalism for Artificial Intelligence</b>",
+ Proceedings of the 1973 International Joint Conference on Artificial Intelligence,
+ pp. 235-246.</p>
+ <p><a name="Kelsey99"></a>[Kelsey99] John Kelsey, Bruce Schneier, "<b>The
+ Street Performer Protocol and Digital Copyrights</b>", First Monday,
+ vol 4, no 6, 1999. Online at <a href="http://www.firstmonday.dk/issues/issue4_6/kelsey/index.html">http://www.firstmonday.dk/issues/issue4_6/kelsey/index.html</a>.</p>
+ <p><a name="Krecke01"></a>[Krecke01] Elisabeth Krecke, "<font color="#FF0000">some
+ title about law on the internet</font>" Proceedings of <i><a href="http://panoramix.univ-paris1.fr/AHTEA/colloques.html">Austrian
+ Perspective on the New Economy</a></i>, 2001.</p>
+ <p></p>
+ <p><a name="Lavoie01"></a>[Lavoie01] Don Lavoie, "<b>Subjective Orientation
+ and Objective Wealth: Entrepreneurship and the Convergence of Groupware
+ and Hypertext Capabilities</b>", Proceedings of <i><a href="http://panoramix.univ-paris1.fr/AHTEA/colloques.html">Austrian
+ Perspective on the New Economy</a></i>, 2001.</p>
+ <p><a name="Lessig99"></a>[Lessig99] Larry Lessig, "<b>Code, and Other
+ Laws of Cyberspace</b>", Basic Books, 1999. Excepts online at <a href="http://code-is-law.org/">http://code-is-law.org/</a>.</p>
+ <p><a name="Mill69"></a>[Mill69] John Stuart Mill, "<b>On Liberty</b>",
+ London: Longman, Roberts & Green, 1869. Online at <a href="http://www.bartleby.com/130/2.html">http://www.bartleby.com/130/2.html</a>.</p>
+ <p><a name="Miller95"></a>[Miller95] Mark S. Miller, E. Dean Tribble, Ravi
+ Pandya, Marc Stiegler, "<b>The Open Society and its Media</b>",
+ in Prospects in Nanotechnology, ed. Markus Krummenacker, James Lewis;
+ Wiley, 1995. Proceedings of the 1992 <i>First General Conference on Nanotechnology:
+ Development, Applications, and Opportunities</i>.</p>
+ <p></p>
+ <p><a name="Miller00"></a>[Miller00] Mark S. Miller, Chip Morningstar, Bill
+ Frantz, "<b>Capability-based Financial Instruments</b>", Proceedings
+ of Financial Cryptography 2000, Springer Verlag. Online at <a href="http://www.erights.org/elib/capability/ode/index.html">http://www.erights.org/elib/capability/ode/index.html</a>.</p>
+ <p><a name="Rees96"></a>[Rees96] Jonathan Rees, "<b>A Security Kernel
+ Based on the Lambda-Calculus</b>", (MIT, Cambridge, MA, 1996) MIT
+ AI Memo No. 1564. <a href="http://mumble.net/jar/pubs/%20secureos/">http://mumble.net/jar/pubs/
+ secureos/</a>.</p>
+ <p><a name="Selgin01"></a>[Selgin01] George Selgin, personal communication.</p>
+ <p><a name="Shapiro99"></a>[Shapiro99] Jonathan S. Shapiro, "<b>EROS:
+ A Capability System</b>", Ph.D. thesis, University of Pennsylvania,
+ 1999. Online at <a href="http://www.cis.upenn.edu/%7Eshap/EROS/thesis.ps">http://www.cis.upenn.edu/~shap/EROS/thesis.ps</a></p>
+ <p><a name="Steckbeck01"></a>[Steckbeck01] Mark Steckbeck, Peter Boettke,
+ "<b>Akerlof Problems, Hayek Solutions: Local knowledge and self-enforcement
+ in E-Commerce</b>", Proceedings of <i><a href="http://panoramix.univ-paris1.fr/AHTEA/colloques.html">Austrian
+ Perspective on the New Economy</a>, </i>2001.</p>
+ <p><a name="Stiegler98"></a>[Stiegler98] Marc Stiegler, "<b>Introduction
+ To Capability Based Security</b>", Online at <a href="http://www.skyhunter.com/marcs/capabilityIntro/index.html">http://www.skyhunter.com/marcs/capabilityIntro/index.html</a>.</p>
+ <p><a name="Szabo97"></a>[Szabo97] Nick Szabo, "<b>Formalizing and
+ Securing Relationships on Public Networks</b>", First Monday, vol
+ 2 no 9, 1997. Updated copy at <a href="http://www.best.com/%7Eszabo/formalize.html">http://www.best.com/~szabo/formalize.html</a>.</p>
+ <p><a name="Tribble95"></a>[Tribble95] Eric Dean Tribble, Mark S. Miller,
+ Norm Hardy, Dave Krieger, "<b>Joule: Distributed Application Foundations</b>",
+ http://www.agorics.com/joule.html, 1995.</p>
+ <p><a name="Vinge84"></a>[Vinge84] Vernor Vinge, "True Names",
+ Bluejay Books, 1984, Online at <a href="http://progoth.resnet.gatech.edu/truename/truename.htm">http://progoth.resnet.gatech.edu/truename/truename.htm</a></p>
+ <p><a name="Walker"></a>[Walker] Miriam Walker, Ka-Ping Yee, "<b>Interaction
+ Design for End-User Security</b>", in preparation.</p>
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- <a href="../../../elang/index.html">E
- Language</a> <a href="../../../smart-contracts/index.html">Smart
+ <a href="../../../elang/index.html">E Language</a>
+ <a href="../../../smart-contracts/index.html">Smart
Contracts</a> <a href="../../../related.html">Related</a>
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