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markm@eros.cs.jhu.edu
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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>
+ Perspectives 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
+ <h1>Abstract</h1>
+ <p>Inadequate and ill-adapted property institutions in the third world prevent
+ the extralegal assets of the poor from serving as capital. In particular,
+ the absence of credible systems of title transfer makes real estate holdings
+ ineffective as collateral for loans. How can this barrier to wealth creation
+ be surmounted? Country-by-country institutional reform is possible, but
+ inevitably slow. New options based on computer networks and trusted computational
+ agents may provide a shorter path. By leveraging trust in first-world
+ institutions while enabling the evolution of contractual arrangments that
+ fit local needs and traditions, this approach could bring advanced property
+ systems to regions now paralyzed by their absence.</p>
+ <h1><a name="intro"></a>Introduction</h1>
+ <p>Hernando de Soto, in <i>The Mystery of Capital</i> [<a href="#deSoto00">deSoto00</a>],
+ shows that the poor of the world have, in his terminology, <i>assets</i>
+ vastly in excess of their <i>capital</i>. In one study, de Soto's associates
+ surveyed neighborhoods in various poor countries, assessing the value
+ of buildings which were not formally titled; the extrapolated 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. In identifying a crucial mystery -- the failure of these assets
+ to serve as capital for their owners -- de Soto has identified a great
+ opportunity for economic betterment.</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
@@ -87,46 +96,38 @@
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,
+ <p>De Soto hopes to bring the power of capital to the poor by strengthening
+ their property rights in accord with historical precedents in the advanced
+ economies -- that is, by reforming and extending the legal systems and
+ bureaucracies of their various national governments. This is no easy task:
+ the benefits of reform flow to the now-marginalized property owners, but
+ the benefits of inertia rest with the power holders. De Soto argues powerfully
+ that property-system reform should be a primary political objective, and
+ we concur.</p>
+ <p>This paper, however, explores another path to de Soto's objective, one
+ opened by new technologies of the Net. 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>
+ <h1><a name="nohubs"></a>Networks of Trust</h1>
<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, markets 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>
+ ourselves, held the naive view that once oppression was out of the way,
+ markets 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 observations of how the world's <i>cultures</i> differ
regarding attitudes and proclivities towards trust -- how easily, and
@@ -191,7 +192,7 @@
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 (inspired by [<a href="#Granovetter73">Granovetter73</a>]),
- we can analyze the Fukiyama low-trust world (in which the fanout from
+ we can analyze the Fukuyama low-trust world (in which the fanout from
each node is small) and the de Soto missing-hub world, and immediately
recognize which effect has the greater impact on a society's effectiveness:
it is the absence of the hubs that ultimately prevent large scale complex
@@ -219,30 +220,30 @@
<p>But shouldn't this situation be an ideal growth medium for hubs? 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 hub backbone
- grew spontaneously in the west. Absent government oppression we should
- indeed expect it to grow here as well. However, the west's backbone of
+ grew spontaneously in the West. Absent government oppression we should
+ indeed expect it to grow here as well. However, the West's backbone of
hubs 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
+ The 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,
+ <p>One of the depressing features of the pictures painted by both Fukuyama
+ and de Soto is that the only hope they see for these societies is homegrown,
with each individual third world nation bootstrapping itself through all
these steps, including, for de Soto, the evolution of their own hubs;
or the reform and transformation of each society's national government
into a system that may be widely trusted. Well, it took a long time for
- the west. If they must recapitulate our path, it will take them a long
+ 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
+ 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 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 transfer.</p>
- <p>While all these hubs are valuable for the fomation of wealth creating
+ <p>While all these hubs are valuable for the formation 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
@@ -255,7 +256,7 @@
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 creation of extra-legal title companies
+ <p>Although de Soto documents the creation of extralegal 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 Path</h3>
@@ -263,7 +264,7 @@
can fill this crucial titling role in a nation are formal ones backed
by government itself. A government bundles together widespread recognition,
some sense of legitimacy, and powers of enforcement. This is the strategy
- de Soto has adopted, converting extra-legal assets, village by village,
+ de Soto has adopted, converting extralegal 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
@@ -272,7 +273,7 @@
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
+ <p>De Soto's isn't the first attempt to title the informals' 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
@@ -303,13 +304,13 @@
to hubs, whose wide scope would seem to require 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 somehow 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>
+ is 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 somehow 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,
@@ -317,6 +318,17 @@
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>
+ <p>Can we sidestep this brutally painful process? Perhaps with 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>. Describing how existing
+ incentives and new technologies <i>could</i> give rise to new wealth-creating
+ institutions may help us coordinate our activities to move the world in
+ this direction. We describe these possibilities in mostly abstract terms
+ until the section <i>Video Contracts</i> below, in which we introduce
+ another technological ingredient -- one for connecting this abstract world
+ to the concrete lives of the poor.</p>
<div align="center">
<table cellpadding="12">
<tr>
@@ -328,8 +340,6 @@
</tr>
</table>
</div>
- <p>Can we sidestep this brutally painful process? Perhaps 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
@@ -343,10 +353,10 @@
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,
+ in the third world because of the pervasive spread of western media: shows
+ ranging from CNN to Dallas and Baywatch have granted name recognition
+ and 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 hubs, 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
@@ -363,9 +373,9 @@
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 hubs deal with the idiosyncracies of each village's <i>people's
- law</i>, the idiosyncracies that sabotage traditional governmental attempts
+ <h1><font color="#000000"><a name="smart-contracts"></a>Smart Contracts</font></h1>
+ <p>How might such hubs deal with the idiosyncrasies of each village's <i>people's
+ law</i>, the idiosyncrasies 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>
@@ -383,7 +393,7 @@
<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
+ with the need for separate enforcement. 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
@@ -401,9 +411,9 @@
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
+ a similar logic, in that a participant effectively secures their good
+ performance with the value of their reputation capital. Such arrangements
+ 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. In this paper we explore escrow-based smart
contracts, not because we expect this form to dominate, but because their
@@ -433,11 +443,11 @@
square of the board, taking us to board state B. Alice might not respond
soon enough, in which case Bob may withdraw his offer by taking back the
knight, bringing us back to state A. That's why the first transition arrow
- is shown as bidirectional.</font></p>
+ is shown as bi-directional.</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, taking
us to state D. At this point, either party may still decide they're unsatisfied,
- withdraw their piece, and reenter the loop of bidirectional arrows (at
+ withdraw their piece, and reenter the loop of bi-directional arrows (at
B or C). Or, while in board state D, Bob may pick up the money offered
by Alice, accepting Alice's offer. This is the irreversible commitment
step shown by the bold unidirectional arrow, and takes us to state E.
@@ -500,19 +510,18 @@
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
+ this money to be only a piece on the board, which can be picked up (transferred
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> -- the contract
- host, merely by running the contract, ensures that rights in escrow can
+ host, merely by running the contract, ensures that erights in escrow can
only be released under the agreed conditions, without needing to understand
- those conditions.</p>
+ those conditions or those erights.</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>
+ possible which further limit a player's vulnerability to a dishonest contract
+ host or issuer, but these are beyond the scope of this paper.) </p>
<p> The money is an eright in part because it is <i>third-party assayable.
</i> Even though Bob does not currently possess this eright, Bob, through
the contract host, can determine which issuer backs this eright, and what
@@ -531,7 +540,7 @@
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 simple clear example is the <i>covered
- call option</i>. (Such instruments are kindergarden finance for many,
+ call option</i>. (Such instruments are kindergarten 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,
@@ -542,7 +551,7 @@
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 A, the stock is already on the board. While in this state, neither
- Alice nor Bob may pick up the stock. An new element in the game is the
+ Alice nor Bob may pick up the stock. A new element in the game is the
game clock, attached to a transition arrow, that only permits that transition
after a deadline has expired. Should the deadline expire while the game
is still in state A, Bob could then pick up his stock and go home, leaving
@@ -575,13 +584,13 @@
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.
De Soto's <i>capital</i>, besides being an abstraction built from widely
- tradeable rights, is also itself widely tradeable, enabling further abstraction
+ tradable rights, is also itself widely tradable, enabling further abstraction
-- the creation of yet more forms of capital.</p>
<h3><img src="images/7-layering.gif" width="308" height="304" align="right">Networks
of Games</h3>
- <p>What we need, quite simply, to turn this new right Alice holds -- the
- right to sit in the left chair, ie, the right to play the left side of
- this on-going game -- into an eright, a third party assayable transferable
+ <p>What we need, quite simply, to turn this new electronic right Alice holds
+ -- the right to sit in the left chair, i.e., the right to play the left
+ side of this ongoing game -- into an eright, a third-party-assayable transferable
electronic right. To do so requires an issuer for this new right. Since
the contract host is already managing access to this chair, we may as
well have it double as the issuer for the eright to sit in this chair.
@@ -606,7 +615,7 @@
<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 -- while the options game is in state A -- she encounters Fred,
- who would also find this position valuable. Fred, were he convinced that
+ who would also find this situation valuable. Fred, were he convinced that
Alice's chair sitting rights mean what Alice says they mean, would be
willing to play a different game on contract host #3, perhaps our original
negotiation game, in which this right, issued by contract host #1, would
@@ -616,13 +625,13 @@
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 (the source code of the program) and the current
+ the text of the contract (the source code of the program), the current
state of the board, and the assays of all the pieces presently on the
- board (ie, escrowed by the game). In theory, this should be sufficient
+ board (i.e., escrowed by the game). In theory, these should be sufficient
for Fred to figure out what these derived rights are, so third party assayability
has been provided in theory, but not yet in practice.</p>
<p>Alice, who presumably understands the game she's playing, can help Fred
- figure this out, and Fred can accept this help, without any trust required
+ figure this out, and Fred can accept Alice's help, without 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
@@ -630,74 +639,237 @@
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>Resolving the Conflict</h3>
+ <h3><a name="resolution"></a>Resolving the Conflict</h3>
+ <p>The above scenario, applied to informally owned assets, could resolve
+ the conflict de Soto explains, but without resort to procrustean homogenization
+ of legal systems. The informally owned assets are not the literal physical
+ objects themselves, they are rights derived from these objects according
+ to informal local laws and negotiated arrangements. To the extent the
+ logic of these arrangements can be successfully expressed in the new language
+ of smart contracts -- with more literal physical objects represented as
+ underlying assets, <i>as if</i> these had once been separately owned --
+ then the smart contract will have preserved this local knowledge in a
+ form that can be uploaded to widely trusted contract hosts, transforming
+ them into capital. The contract hosts would specialize in providing the
+ trust connectivity needed for global transferability. Each smart contract
+ would specialize in providing the local knowledge. Using our new technological
+ enablers -- the ability to safely and faithfully run rights-handling programs
+ one neither trusts nor understands -- these two specialties can be smoothly
+ combined without homogenizing the knowledge or imposing an impossible
+ learning burden on the contract host. </p>
+ <p>There will remain pressures for homogenizing capital-creating-contracts
+ -- normal market pressures. In the above scenario, Alice will no longer
+ lose the sale to Fred through Fred's lack of trust in Alice. But she is
+ still in danger of losing the sale through Fred's inability to understand
+ the contract's meaning. Further, only standardized contracts can create
+ fungible assets tradable on large exchanges. However, these pressures
+ can gradually work themselves out over time, and in competition with the
+ benefits provided by custom contracts, well after starting on the digital
+ path. This is to be contrasted with the governmental path, in which pervasive
+ rule homogenization is the necessary first step, and therefore also a
+ major barrier to starting on the governmental path.</p>
+ <h1><a name="legitimacy"></a>Backing and Legitimacy</h1>
+ <p>For purely electronic assets, like fiat money and stock, at this point
+ we have, perhaps, an adequate picture. The title listing for these assets
+ is the reality of ownership -- there is no separate issue of physical
+ control that may or may not follow along. To explain how smart contracts
+ may be applied to Wall Street, we could perhaps stop here. But we have
+ not yet succeeded at the mission we set out on -- to establish credibility
+ of title transfer at a distance, in order to unlock the potential capital
+ in the poor's $9.3 trillion dollars of extralegal buildings, land, etc.</p>
+ <p>The actual control of the physical assets in question is determined,
+ not by their title listing, but by consensus of the governing community
+ in question. Why wouldn't the digital path fail in the same way the pre-de
+ Soto governmental attempts fail? Why would these communities consider
+ these title transfers legitimate and honor them?</p>
+ <p>The governmental path has an advantage here. Governments employ a vast
+ apparatus of coercive enforcement to enforce the outcomes they cliam are
+ legitimate, such eviction following a title transfer. Still, even with
+ this advantage, in the previous failed attempts these title transfers
+ were not seen as legitimate and not honored. Under these circumstances,
+ even governments mostly understood that coercive enforcement would have
+ had too terrible a cost. De Soto documents well the repeated victories
+ of squatters over governmental law.</p>
+ <p>The missing ingredient was the need to accomodate pre-existing local
+ arrangements. These are the source of the legitimacy governing current
+ control of the property, and any new system can only be seen as legitimate
+ if it incorporates and build on the old. On this issue, the digital path
+ has a huge advantage over the governmental one. But what of the disadvantage?
+ The Net is a purely non-coercive medium, it transmits only information
+ -- effectively speech -- but cannot transmit force. Smart contracts can
+ change their electronic representations about the world -- such as title
+ -- but they cannot force the world to come along. Unlike government-based
+ title transfer, these changes of title are not <i>backed</i> by a coercive
+ enforcement apparatus. How may we compensate for this lack? For concretenness,
+ in order to establish possibility, we propose here two complementary techniques,
+ but we do not presume to forsee what the actual outcome of the market
+ discovery process will be. This should be an area ripe for entrepreneurial
+ invention. </p>
+ <h3><a name="ratings"></a>Ratings</h3>
+ <p>The issue of credibility does not require all title listings to have
+ high credibility. Rather, it is adequate for distant traders, that have
+ no knowledge of a particular governing village, to nevertheless have some
+ reliable basis for judging the credibility of particular title listings.
+ An obvious answer is to introduce another trusted intermediary institution
+ into this market -- title insurance. Once the digital matures, this solution
+ may be ideal, but as a way to get started it has a fatal problem -- it
+ requires a crippling up front capital investment, in order to cover the
+ massive potential liabilities. Rather, another familiar form of intermediary
+ may be adapted to this situation.</p>
+ <p>Bond rating agencies provide the market with an estimate of how likely
+ it is that a business or government will actually meet the obligations
+ represented by its outstanding bonds. The rating agency does not attempt
+ to estimate what the price of the bond should be -- that is left to the
+ market, which takes these likelihoods into account. A bond rating agency
+ does not put its money where its mouth is -- it does not issue bond insurance
+ to back its likelihood estimates. Rather, it backs its estimates with
+ its reputation, which can become quite valueable, but is still cheaper
+ than issuing insurance.</p>
+ <p>Similarly, in our situation, we can imagine of third party raters that
+ post judgements of the likelihood that transfer of a given title will
+ actually be honored [<a href="#Stanley01">Stanley01</a>]. Simply recording
+ each village's track record of honoring past title transfers, and assuming
+ the future will be like the recent past, is a low overhead procedure that's
+ plausibly adequate. And it places each villiage in an iterated game with
+ the system as a whole, providing it an incentive to treat these titles
+ as legitimate claims. We can think of this as a credit report, not for
+ an individual, but for a village and its system of local law.</p>
+ <h3><a name="video"></a>Video Contracts</h3>
+ <p>But legitimacy is more than just preserving local arrangements, and it
+ is more than just incentives or force. It is knowing in your bones what
+ the right thing is, based on the kinds of evidence you are used to taking
+ into account. One day a distant voice on the phone tells Bob to vacate
+ his family home because, it claims, his late father Sam took out a loan
+ from a distant bank Bob has never heard of. Bob believes that if this
+ were true, Bob would have heard about it from Sam. The evidence presented
+ by these disembodied strangers are impersonal electronic records Bob can
+ hardly understand, much less verify. Perhaps Bob is told the veracity
+ of these records can be verfied by cryptographic means. Why should Bob
+ believe them? Absent coercive power to evict, why should Bob even take
+ them seriously? Why not just stay in his home?</p>
+ <p>Bob's community does have power of various sort over him, probably including
+ the power to evict, if there is sufficient local consensus in the legitimacy
+ of the claims of the outsider. However, Bob is a known member of the community.
+ Why would they take an outsider's word over his? The incentives produced
+ by rating agencies is far too weak an answer.</p>
+ <p>Into this situation, let's introduce Szabo's <i>Video Contract</i> [<a href="#Szabo98">Szabo98</a>].
+ As Szabo explains, a contract is supposed to represent a meeting of the
+ minds, but complex lawyer-written contracts on paper no longer plausibly
+ meet this standard. Verbal contracts often do at the moment of the handshake
+ -- both parties have just had a rich conversational interaction, full
+ of all the concious and subconcious cues we use to understand what each
+ other understands -- so they plausibly have a good sense of what they
+ jointly mean to agree to. However, memory is fleeting, so people turned
+ instead to paper to record agreements, trading away richness, sincerity,
+ and vividness in order to get permanence. At the time it was a necessary
+ trade.</p>
+ <p>But no longer. Using video cameras, also rapidly dropping in price, contracting
+ parties could now record their conversation about the contract's meaning,
+ and store it with the contract for future reference. Ideally, a title
+ listing could store the entire chain of videos for the chain of contracts
+ by which the property changed hands -- starting with the initial video
+ interview at the time the initial title record was created. The outsider
+ could show, to both Bob and his community, the video of the conversation
+ with Sam about the meaning of the contract. For most communities, seeing
+ Sam explain clearly what rights he's trading away will be enough to establish
+ legitimacy. After all, that's Sam talking, not some outsider making dry
+ claims about Sam's past intentions. Such records should also help overcome
+ barriers of language and literacy.</p>
+ <h3></h3>
+ <h1>Why the Third World First?</h1>
+ <p>This new world of Net-based jurisdiction-free coercionless smart contracting
+ -- the digital path -- is an option for the first world as well as the
+ third. Both groups stand to gain tremendously by this transition. Virtually
+ all progress to date towards the digital path [<a href="#Lessig99">Lessig99</a>,
+ <a href="#Krecke01">Krecke01</a>] has been in the first world. Nevertheless,
+ once technology costs become inconsequential, we expect the third world
+ to overtake and then lead the first in making this transition. Why?</p>
+ <h3>Comparative Legitimacy</h3>
+ <p>Primarily because, once again, of the issue of legitimacy. The character
+ of legitimacy in the first world is quite different than the legitimacy
+ we have been discussing among the third world's informals. First world
+ societies, having made the transition to the governmental path long ago,
+ have enjoyed great wealth, but have paid a subtle price in flexibility.
+ In most rich first world countries the issue of legitimacy is inextricably
+ coupled to legality. With the exception of Italy, for a business in these
+ countries to be judged legitimate by the culture, and for others to consider
+ their dealings with this business to be legitimate, the business must
+ be legal -- it must be operate within the formal legal system. By contrast,
+ in Italy and among the informals, the formal legal system has no monopoly
+ on legitimacy -- many extralegal institutions enjoy widespread popular
+ legitimacy.</p>
+ <p>As explained above, a new system of law will only be seen as legitimate
+ if it accomodates, incorporates, and builds on pre-existing systems of
+ legitimacy. The pre-existing formal and informal systems each have a very
+ different kind of great complexity; and the effort to accomodate this
+ complexity, to express these rules in the language of smart contracts,
+ can seriously impede these transitions. </p>
+ <p>Among the informals the great complexity comes from the sheer number
+ of local arrangements that need to be expressed. The people's law of each
+ individual village, being largely unwritten, must be extremely simple
+ compared to formal law. Also, the very informality of these systems allows
+ it to compromise. As long as an adequate spirit of the arrangements is
+ uploaded, imperfect expressions can often be judged to be <i>good enough</i>.
+ This lets the transition get started incrementally, village by village,
+ and imperfectly.</p>
+ <p>By contrast, although there are far fewer separate systems of formal
+ law, each is a vast cancerous growth of complexity that no one even pretends
+ to understand; the U.S. tax code alone probably exceeds the aggregate
+ complexity of all informal law taken together. However, because of the
+ formality with which this law is administered, and the absence of competitive
+ pressures, this system brooks no compromise except through politically-driven
+ change. This is a high enough bar that a smart contract system, legitimate
+ by this standard, might emerge so slowly as to be a non-issue.</p>
+ <h3>Homogenization Costs</h3>
+ <p>The costs of rule homogenization discussed above, to be paid on the governmental
+ path, is a cost that has already been paid and largely forgotten in the
+ first world. The first world has already lost this great source of diversity,
+ so the digital path's option to avoid paying these costs is not a selling
+ point there.</p>
+ <h3>Cell Phones in Eastern Europe</h3>
+ <p>Cell phones first became society-wide hits in poor countries with terrible
+ telecommunication, not in rich high-tech societies. (My own observations
+ of Prague <i>vs.</i> Silicon Valley in 1998 corroborate this -- cell phones
+ were everywhere in Prague.) Not having a working phone system, cell phones
+ offered a huge advantage over their prior situation. They offered a much
+ more minor improvement in societies where the land lines work. Those without
+ an adequate prior system were able to more quickly leapfrog over to a
+ better system. There is no necessary sequence of telecommunication systems
+ that each society must separately recapitulate.</p>
+ <p>Likewise, the informals have no access to working global networks of
+ trust and commerce. The digital path offers them tremendous new opportunities.
+ In the West, it provides a smaller improvement, and an improvement over
+ a system many consider imperfect but adequate.</p>
+ <h3>Saving the First World</h3>
+ <p>Should the third world be the first to succeed at the digital path, and
+ should this in fact unleash their potential capital, causing markets to
+ bloom, creating vast wealth, how would this effect the first world?</p>
+ <p>Formal laws in the first world do change under political pressure. One
+ of the more effective sources of pressure are those who stand to gain
+ from large scale commerce with the rest of the world. Once a signicant
+ part of the world's economy is occuring in the digital path, first world
+ businesses would then face a choice -- trade with these networks or stay
+ legal-legitimate. This is an unpeasant choice both for them and their
+ governments. The pressures will be great to legalize trade with these
+ jurisdiction-free networks of commerce. Once such unregulatable trade
+ is made legitimate, the damn will have burst. What will be the character
+ of the resulting world?</p>
+ <h1>The Rule of Law and Not of Men</h1>
+ <p>Surprisingly perhaps, it may best be described as a pure form of the
+ classical liberal ideal -- <i>the rule of law and not of men</i>. Indeed,
+ it more literally realizes the meaning of those words than anything the
+ old classical liberals could possibly have conceived. </p>
<p><font color="#FF0000">*** to be written</font></p>
- <h3>Why the Third World First?</h3>
- <table cellpadding="12" border="1">
- <tr>
- <th>
- <div align="left"></div>
- </th>
- <th>
- <p align="left">Purely electronic rights<br>
- (money, stock)</p>
- </th>
- <th>
- <div align="left">Pubic eTitle in physical goods<br>
- (tractor, land)</div>
- </th>
- </tr>
- <tr>
- <th>
- <div align="left">Digital Path:<br>
- Jurisdiction-free<br>
- Coercionless </div>
- </th>
- <td>
- <div align="left">10/10th of law</div>
- </td>
- <td>
- <div align="left">Incentives on corrupt cops</div>
- </td>
- </tr>
- <tr>
- <th>
- <div align="left">Jurisdictional:<br>
- public records<br>
- lawyers, cops</div>
- </th>
- <td>
- <p align="left">Behavior as 9/10th of law.</p>
- <p align="left">Split contracts</p>
- </td>
- <td>
- <div align="left">Incentives on corrupt courts</div>
- </td>
- </tr>
- <tr>
- <th>
- <div align="left">Informal:<br>
- local consensus</div>
- </th>
- <td> </td>
- <td>
- <div align="left">Can eTitle establist popular legitimacy?</div>
- </td>
- </tr>
- </table>
- <p><font color="#FF0000">*** to be written</font></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>
+ <h3><a name="acks"></a>Acknowledgments</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>
+ Chris Peterson, Jonathan Shapiro, 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="Birch97"></a>[Birch97] 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
@@ -724,12 +896,12 @@
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>
+ Perspectives 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>
+ Perspectives 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>",
@@ -739,10 +911,15 @@
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><a name="Miller99"></a>[Miller99] Mark S. Miller, "<b>Observations
+ on AMIX, The American Information Exchange</b>", 1999. Online at
+ <a href="http://www.erights.org/smart-contracts/history/index.html">http://www.erights.org/smart-contracts/history/index.html</a>.</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="Pospisil71"></a>[Pospisil71] Leopold Pospisil, "<b>The
+ Antropology of Law: a comparative theory</b>", Harper and Row, 1971.</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/
@@ -750,16 +927,19 @@
<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>
+ 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="Stanley01"></a>[Stanley01] Terry Stanley, personal communication.</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>
+ Perspectives 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="Szabo98"></a>[Szabo98] Nick Szabo, "<b>Video Contracts</b>",
+ 1998. Online at <a href="http://szabo.best.vwh.net/video.html">http://szabo.best.vwh.net/video.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>
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