Building the Bitcoin Economy: The Complete Contract Governance Platform
By: Prateek Goorha
Tags: Contracts, Economics, Bitcoin, Blockchain

Building the Bitcoin Economy: The Complete Contract Governance Platform

TL;DR: Bitcoin’s overwhelming value proposition is as a complete contract governance platform. As such, its unique transactional properties allow the creation of Bitcoin powered SaaS platforms that fundamentally disrupt many aspects of traditional contract applications, far beyond “smart contracts” alone.

If you have been following the crypto-universe for a few years, you can be excused for feeling that we seem to have lost the plot somewhere along the road. Perhaps, not entirely. But in a very fundamental way we are lost among the trees and have missed the forest.

Our point is this: Bitcoin’s overwhelming value proposition is as a complete contract governance platform. As such, its unique transactional properties allow the creation of Bitcoin powered SaaS platforms that fundamentally disrupt many aspects of traditional contract theory, far beyond “smart contracts” alone.

Bitcoin offers a distinct third alternative to the price mechanism of a free market and the top-down coordination mechanisms of organizations such as firms and institutions. This third alternative is a what we believe will open up an entirely new set of economic orderings: one where the functions of firms and institutions, on the one hand, and the price mechanism on the other, are, to varying degrees, both subsumed. This principle of organization is a cryptographic stigmergy.

Stigmergic organization of social activity occurs when actors self-organize by taking cues from the environment that they operate within; information relevant for the self-organization to occur in the pursuit of beneficial activity is provided by their environment.

Bitcoin’s value is in creating stigmergic environments through the creation of trust platforms.

More specifically, Bitcoin’s capacity to serve as a stigmergic environment comes from its ability to provide a platform for the creation of complete contract solutions. By a complete contract solution we simply mean a mechanism that can be implemented to reify a technology for the mapping between information and outcomes for any given context.

What does that mean precisely?

Contracts

Contracts are pervasive. They are, quite literally, everywhere. A firm is nothing but a repository of contracts: contracts with employees, with unions, with suppliers, with consumers, and so forth. The global economy is almost exclusively defined by contracts: contracts exist between countries in the context of pacts and treaties over trade, loans, and other cooperative agreements of a very broad variety. Contracts are very much part of life for individuals in equal measure: we enter into contracts with our lawyers, the builders of our homes, our insurance companies, the DJ whom we hire for our garden party, and much else besides.

These are all incomplete contracts. What this essentially means is that investments (of effort, actions, money, capital, or whatever) are made on the basis of which some outcome is realized before those who are party to the contract receive their payoffs. However, investments made by one party are put at risk whenever the other party undertakes some form of undesirable behavior. This alters the bargaining power between the parties to a contract and even reduces the incentive to enter into the contract ex ante.

Incomplete contracts are called incomplete because they cannot be fully specified; they leave gaps of information open that then create indescribable contingencies relevant to the future states of the contract. The cost to specify these contingencies may be prohibitively large, or the contingencies may be unforeseeable before investments are made. Indeed, it may even be rational to deliberately leave a degree of incompleteness built into the contract in order to permit some scope for desirable variability in future efforts around a shared reference point.

In any case, the effect is that the resulting contract is not verifiable by any independent third-party entity. When information is revealed that is contrary to the expectations of one or more of the contract’s participants, resolutions are few. The role of the third-party, usually the courts, is only relevant ex post, to adjudicate on the animus contrahendi, or the intentions the parties to a contract had when they entered into it.

A workaround for this problem, where possible, is to provide ownership to the party whose investments are most vital. This has been a fundamental justification for the existence of the firm in economic theory. The firm acts as the de facto verifier of last resort.

In all the instances of incomplete contracts, we could arguably create — explicitly — some entity in whom we reify the responsibility for the verification of parameters pertaining to contractual performance. We do this to the extent possible, and when we fail, we tend to live with suboptimal outcomes that are open to expensive ex post litigation costs, renegotiation costs, or, simply, an increased probability that the economic activity is altogether foregone, ex ante.

Enter Bitcoin as a Mechanism Creator

Starring: Coase

When asked what is Bitcoin’s use case, you might have been tempted to conclude that it is “sound money”. Perhaps, you might have ventured that it is the archetype of a new asset class, and not much more. Or, you may even have suggested that it is worthless, and that the crux of the substance is the blockchain technology.

If we are right, then none of these viewpoints are accurate. At the very least, each is utterly incomplete. And, not realizing why is akin to driving around in a car with a wheel missing. You are very likely to be hobbling not just the your own journey, but everyone else’s journey who you have taken along as passengers as well.

Bitcoin’s value proposition is its ability to provide a complete contractual mechanism that has never existed in the history of economic orderings in societies. A significant side-effect of this, it is true, is that Bitcoin is a type of money with very desirable characteristics; it is a type of asset that is novel in comparison to all others; and it is the poster-child for a promising technology.

Ironically, this viewpoint has been hidden in plain sight in Nakamoto’s white paper. Bitcoin was built as the only payment system that was compatible with a network economy. The network economy operates on certain simple but profound principles that are essentially all based upon deepening network economies over an expanding set of goods and services. To this, Bitcoin adds trust economies and serves as its platform.

Trust economies are created when transactions costs fall by virtue of shifting the organization of economic activity from the traditional economy to the stigmergic organization that Bitcoin can provide.

Such economies are substantial and significant across a range of situations that are marked by contractual incompleteness arising routinely from poorly defined and ineffectually enforced property rights. This is the crypto-Coase theorem, and it is profoundly important to understanding why Bitcoin can become central to instigating valuable economic reorganizations en masse. Bitcoin generates trust economies that lower transactions costs over alternative forms of economic organization.

To see this more elementally, consider the blockchain technology that is so often seen as the “real” innovation in Bitcoin.

The familiar mantra is that blockchains instantiate decentralized ledgers of transactions. However, the desirable features of blockchains — temporal and spatial immutability, trustless verifiability, expansibility — are bolstered by the strength of the consensus protocols that they use. The stronger such protocols are, the more transparently and clearly these desirable features become reified in the applications. The fact that the Bitcoin blockchain can itself be forked off in the creation of patently nonsensical assets is proof that the creation of a cryptoeconomy requires more than the simple application of a blockchain. The paradox is that this constitutes a fundamental tradeoff: The myriad applications of blockchains that are based on the use of more frictionless protocols increase the risk of compromising those ideals fundamentally.

Yet, these are necessary frictional costs in the construction of a platform of trust economies. Protocols are like the feathers of the peacock. They represent a handicap principle for blockchain applications. Trust economies, in other words, must be purchased. And nowhere are they better setup to do so than with Bitcoin.