Introducing Bitcoin Contract Governance

Parabolic Trav and Prateek Goorha

TL;DR: Bitcoin not only disrupts money, but also contract law. Bitcoin’s unique architecture, including its scaling solutions and multi-signature wallets, allow entirely new economic orderings that can create strong contract governance without the assistance of legacy financial and legal jurisdictions.

In our last article, Prateek and I introduced the theoretical framework that governs what we call “Bitcoin Contract Governance” (BCG). We want to now take this opportunity to discuss the practical application of this platform and elucidate on some real world use-cases.

First, a quick summary: What is BCG? Answer: It is the potential contracting framework that can be implemented as a platform on the Bitcoin network, enabled by multi-signature wallets. The multisig majority vote protocol allows the transferring of escrowed bitcoin only when certain conditions are met, effectively creating a “contract”. The effect of this, as we shall see, is to drive the contract towards consensus directly for simpler contracts, and probabilistically in the case of more complex contracts by acting as a disciplinary mechanism.

The Multi-Signature Wallet

Multisig wallets trap the intentions of the participants to a contract into a jurisdiction of specific software rules. Multisig fundamentally disrupts traditional government contract law jurisdictions by allowing creation of customizable digital jurisdictions whose rules participants are forced to adhere to if the funds locked there are to be moved. Indeed, the rules provided by digital jurisdictions supplant any nexus of authority, be they enshrined in governments, institutions or even firms. Those who have postulated how contract law could work in an Anarcho-Capitalistic economy finally have a working example provided by Bitcoin.

The voting protocols that govern the multi-sig accounts and wallets at present are merely scratching the surface of what is possible and necessary for a vibrant Bitcoin economy. In order to implement more robust mediation platforms, far more customizable voting protocols, informed by sound microeconomic theory, will need to be developed.

The current design of multisig wallets are such that keys are given to multiple parties, and only a majority consensus of these keys are required to access the funds in order to effect any payments or purchases. For the sake of simplicity, let us consider a three-signature wallet that requires two keys to initiate transfer.

Contract Parties and Digital Jurisdictions

Contracts are routinely examined using the Principal-Agent model in economic theory. The Principal is the residual claimant and entrepreneurial risk-taker, and the Agent is assumed to be risk neutral. In our context, the Principal can be imagined as the Principal Initiator and the Agent as the Service Provider. Therefore, the parties to a multi-signature wallet “contract” are:

1. Principal Initiator (funds the account and sets up terms, conditions, and timeline)
2. Service Provider (receives remuneration upon completion of defined tasks to the satisfaction of the Contract Initiator)
3. Mediator (A designated third party who casts the deciding vote or forces negotiation when the other two parties are in disagreement by following contractual specifications and feedback)

The three fundamental forms of these jurisdictions are as follows:

1. Principal-Agent agreement: Where the initiating party feels the service provider has completed her respective obligations, and uses his key to release funds to the service provider. The service provider is assumed to be using her key in the affirmative at all times.
2. Mediated disagreement: This is when the mediating third party is tasked by either the Principal Initiator or the Service Provider to intervene in the capacity as a third-party verifier of the contractual obligations. If they side with the initiator, the funds remain locked and the provider must continue to attempt completion in order to be paid. If they side with the provider, the contract is completed without the consent of the initiator.
3. Mediated negotiation: In the eventuality that there is partial completion, the mediator specifies the scope of works that remain for the contract to be satisfied. This is an instance where the initial contractual incompleteness is resolved by the mediator through the process of negotiation.

The reason why mediated outcomes must be made available as a service for the Bitcoin economy to truly thrive is because a range of Initiator-Provider relations involve a scope of work that cannot be described with precision prior to the work starting. What’s more is that a vast majority of real-world contracts are plagued by this form of incompleteness; they are undertaken “in the shadow of an outside option”, namely that of some third-party mediation. For the Bitcoin economy, this “outside option” of mediation can be handled within the architecture of the network itself. Consider an initiator tasking a provider with a work of art. The provider might produce something extremely abstract that the initiator hates, and refuses to pay the sum agreed on from the wallet. Mediation in this case would involve resolving the intentions based directly on the initiator’s contract specifications and the provider’s feedback before completion.

The Mediator

Let’s talk about the mediator. This is ultimately the crowning achievement of what multisig wallets can ultimately achieve: an incentivized mediator to help move the contract to completion.

When taking a top-down view of what the mediator is trying to achieve, the answer is clearly consensus. To further this fundamental goal, the fee structure applicable to a mediator must be designed in such a manner that it is in its best interests to work with both parties to achieve principal-agent agreement, rather than mediated disagreement. Essentially, mediated disagreement outcomes should pay less, to discourage their frequency. When parties are in agreement, either by initial agreement or mediated negotiation, the contract completion should pay more.

This is in accordance with what we should expect in any contractual situation where potential profits are frittered away through arbitration. So long as the costs of arbitration (that is, the mediator’s fees) exceed those of the losses incurred by both parties to the contract in arriving at a consensual agreement, contractual agreement remains the more attractive outcome.

Mediators will usually be selected through using a reputation market, which we expect to develop as this new layer develops. This would be an online listing and rating service for various types of mediators. We also suspect niche BCG systems may seek out highly reputable mediators from actual practice within the field, like consultants, bankers, or lawyers. Further, as we discussed in our previous article, we imagine that there would be different types of mediators in operation. Some mediators would have relatively straightforward jobs (such as, say, effecting a real-estate transfer with some simple conditions). Others may be much more complicated, involving designing contractual dialogues with other multisig wallets prior to completion, or assisting in overcoming technical or creative hurdles that are limiting the service provider’s ability to deliver the finished work.

Mediators can essentially encapsulate the traditional roles of judge, arbitrator, coach, adviser, and even mentor. Since the rules that govern the mediators’ underlying philosophy ultimately describe the rules beyond the contract terms that the jurisdiction will govern by, unique combinations will exist. Again, this is a system to promote consensus, and is directly incentivized to reduce adversarial outcomes. As we said in our previous article, we see the service that mediators provide essentially as a “trust platform” that is flexible enough to handle a wide variety of contracts across the landscape of economic activity supported directly, or even indirectly, through the Bitcoin network.

The Structure of Contracts

Now that we’ve laid out the fundamental framework between the principal, agent, and mediator, we can consider the finer refinements of the varying pieces that make up a contract.

As explained above, the very idea of an appropriately defined multisig wallet can enable the basis for contractual mediation by creating a digital jurisdiction on-chain. Once this has been established it would thereafter trigger the creation of an off-chain open channel where contract verification occurs “in the shadow of” the digital jurisdiction, just as traditional contracts take place in the shadow of the courts. Naturally, the extent to which a contract can be mediated by using on-chain settlement facilitation alone, as opposed to relying on a mix of on-chain settlement supporting off-chain verification, depends on the degree of incompleteness inherent in the contractual conditions.

It should be noted that these contractual proceedings in the open channel do not necessarily have to be on any blockchain application — in fact, it is arguably inefficient to do so in cases where an ordinary database might suffice — but its output does have to be fed back by the mediator to the settlement layer by first “closing off” the open channel. The incomplete information that required the creation of the open channel, in other words, is first ascertained and resolved before reverting to the on-chain multisig wallet that facilitates the distribution of payoffs to the principal, agent and mediator.

The two key components of contract management that a mediator considers — using its on-chain multisig-wallet based platform together with its off-chain platform-compatible software — are observability and verifiability. Figure 1, shows how these two aspects of a contract interact for our context of mediation. They often work in concert with one another, which is to say that the more observable the actions associated with a contract are the more verifiable they become. In such cases, the mediator’s job is straightforward. The contract is inherently complete and fully specifiable to the degree that it may even be reified with a smart contract.

The figure also shows that the more contracts tend towards completeness, the more suited for they are for being implemented directly on-chain. The more a contract is characterized by incompleteness, the more it benefits from being supplemented by off-chain software mechanisms.

In cases of a dispute between the principal and agent, the mediator relies on reliable data generated by off-chain software solutions to facilitate settlement on-chain; since this is reliably programmable, the mediator can even provide automated inter-mediation to the principal.

However, when the contract involves actions by the agent that are not clearly observable or verifiable, the principal would need to rely on alternate mechanisms. These mechanisms would induce the agent to reveal their level of efforts indirectly, and yield metrics that the mediator can use as checkpoints in its off-chain platform in order to provide more reliable settlement on-chain. More interestingly, the mediator’s on-chain multisig wallet can even be used by the principal as part of the mechanism to induce agent efforts, much as stocks or bonuses might work in the context of a firm where efforts are not always observable.

Degrees of Contractual Completeness

The difference between the two extremes of contractual completeness is worth understanding, for it is precisely in the ability for a mediator’s platform to be able to cater to all situations where the value of Bitcoin Contractual Governance truly resides.

At one extreme, the principal may have access to a very reliable ‘technology’, where by technology we mean the methodology that the principal has to observe the efforts of the service provider. For example, some freelancer contract platforms that track hourly work use screenshot and keystroke tracking tools to visually track and measure that the stipulated terms of the contract are actually occurring. These tools constitute a very good technology, in that they significantly enhance the ability of the principal, and by extension the mediator, to more accurately judge what’s happening. The better the observability, the better the work can be directed in real-time, so as to end up being easily verifiable when the agents submit their work for review. This also allows mediators, if they are so engaged, to be active in reviewing work — much as project managers — as it is happening, to increase the probability of consensus when the final review by the principal occurs.

At the other extreme, the principal may have extremely poor technology to monitor the agent’s progress. Say that the agent is a farmer, and has been hired to grow plantains for the principal in a remote location. The principal may not be able to directly observe or independently verify almost any aspect of the agent’s work. In such a situation, the mediator’s role, ex ante, is crucial, because, absent any such technology, no economic activity may ever take place to begin with. The mediator can open an escrow account that the principal funds. Recall that, upon creation of the multisig account, the farmer will be provided a private key as well, and he can readily be permitted to use it to withdraw a deposit for his services as well as keep track of the state of the funds. The immutability of these funds, subject to predetermined parameters, make the farmer more likely to trust the principal. This encourages the farmer to more truthfully reveal metrics to the mediator over the course of the contract; using these, the mediator then opens an off-chain channel to monitor progress.

It is worthwhile thinking about the versatility of the mediator’s “trust platform”. In classical contract theory, the resolution of the incomplete contract problem is to make the person with the most valuable investment the owner. Doing so resolves the holdup problem. With a mediator platform, the contract can be dynamically adjusted over the course of a contract. Say that, for example, the farmer hits upon some good luck and has a bumper harvest, far in excess of what is needed for the contract. Adjusting ownership on the settlement layer’s multisig wallet in such a case is not only entirely feasible, but provided that the negotiations off-channel are successful, even ownership of the “firm” can be dynamically and tractably altered.

Direct Use Cases

The initial applications of this technology we expect will be custom roll-outs for niche firms with unique points of friction around international trade in goods or services. These firms will likely be those that have somewhat complex existing contractual arrangements with international workers/firms that are costly to enforce and settle payment with. We would also anticipate these firms would specialize in higher order digital services. Firms that operate across multiple contractual jurisdictions are most likely to see the unifying ability of the BCG platform provided by a mediator, since it will drastically reduce their need to rely on a variety of local courts, while also decreasing their settlement periods.

Some possible direct use case examples include:

• Freelancer Payment and Management
• International Contractors
• Contract Template Marketplaces
• International Project Management
• Business Management Services
• Large International Delayed Deliveries
• International Real Estate Purchases & Sales
• Direct Bitcoin Loans & Monitoring
• Innovation Tournaments and Prizes
• Whistle-blowing services
• Bitcoin Family Trusts
• Bitcoin Estate Planning
• Bitcoin Charities

Here’s an example in more detail. Consider an international website design firm that uses a global freelancer workforce. They could develop a software platform with the contract governance infrastructure built into a viewable dashboard. This dashboard may list multiple funded milestones (separate multisig wallets) between the principal and differing groups of service providers (graphic design, coding, video production, etc). It would also show the assignment of each mediator, which may be the same or different in some areas to reflect variance in scope of works. Each milestone could contain submitted or observed data from the service provider revealing the work’s distance from contract completion. It may also have a direct messaging platform where the mediator is in communication with the service provider as needed.

There are many pre-existing software solutions custom designed for a myriad of legacy industries. The fundamental difference is they operate within a specific fiat paradigm and its associated costs (particularly with international trade), but also because they operate in the “shadow of the courts.” Bitcoin Contract Governance bypasses the inefficiencies of relying on the slow-moving, disincentivized courts, and instead places the mediation in the hand of an individual(s) incentivized to achieve the satisfactory fulfillment of the contract. It is our view, as niche solutions take hold, they will begin to reveal profound efficiencies in the Bitcoin economy.

Platform Use Cases

Aside from custom use cases tailored for (initially) niche businesses, there will likely also be various “platform systems” that have subscribed users who use the more generic offering and tailor it to their specific use case. This would be more in line with platforms like salesforce.com, zendesk.com, upwork.com, or airbnb.com. Consider Airbnb, which is what economists call a “two-sided market” since there are network effects among service provides and service users enabled by a platform. Currently, most of the economic rent is captured by the platform provider. With BCG this rent can be redistributed to the participants more favorably.

Platform use cases would be very complex and have a myriad of features to suit many different use cases. These would likely be types of offerings that develop later in the adoption cycle, arising after a sufficient amount of attempting entries try, fail, or succeed, gaining the valuable feedback about how to best order and design the creation of a BCG platform.

Sales Focus Will be Needed

These use cases will not sell themselves and would be complicated to design. Just as salesforce.com has a sales army that specializes in on-boarding new users to their platform, any use case custom service built off our contract logic would equally require the development of traditional business channels. We don’t think there are a lot of programmers and coders who would easily add this to their anticipations, and it’s one of the reasons why this area remains relatively untapped. These solutions need business savvy, but few from the elite business world have shifted over due to their lack of exposure or understand of the underlying technology.

Why Fiat Systems will NOT Embrace Bitcoin

When you realize these international “matching service” companies like Upwork.com or AirBNB are fundamentally built on the fees they can charge by navigating the various fiat jurisdictions, you can understand why they will never cannibalize their own competitive advantage by adding bitcoin as a payment option. If these entrenched platforms ever added Bitcoin payments, their fees would reduce dramatically, perhaps over 90%. Their businesses would need 70% less employees, especially no more lawyers.

Disrupting the “Firm”

Now that you have should have a strong understanding of this contract layer that is built on Bitcoin, it allows us to ask a provocative question: What is a firm?

Answer: It is nothing more than a bunch of contracts with employees, supplies, customers, unions, etc. As contract governance services develop, verification of employee, contractor, and contingent workers performance via mediating agents essentially disrupts the role of managers themselves. Mediators can become third-party managers by simply verifying that employees carry out duties as described in the applicable contract and then confirm payment via multisig after the work is completed in a specified time-frame.

We anticipate this contract governance model will give rise to “Bitcoin Firms”: border-less, jurisdiction-less, structure-less entities that exist entirely in the cloud with no formal corporate structure, and, importantly, fluid workforces and even owners. Instead, they are an initial arrangement of funding in a multisig wallet, possibly with mediators, who use this contract governance system to enter into a myriad of projects managed by mediators. All those “whales” with 10,000 BTC balances can start actually using that money to create accretive economic value.

Final Thoughts on Bitcoin Contract Governance

We in the Bitcoin community are only just awakening to the potential of Bitcoin being far more that a network-compatible P2P payment system. With BCG mediator platforms, we imagine a future where disintermediation will occur across the economy to the detriment of entrenched institutions that have justified their existence as third-party mediators.

The international performance contract and payment market is as important to Bitcoin as the the “coffee” payment market. Once the infrastructure exists that can comfortably facilitate the transaction of a German engineering firm building a $750 million dollar bridge in Seattle with 1425 milestone deliverables all contracted in bitcoin, then we’re likely at the top of the S Curve.

But that won’t happen until someone builds the platform to do it!