The most important conversation about blockchains we are not having.
We live in interesting times. On the one hand, trust in social institutions is falling worldwide for e.g. in the United States, public trust in government over the last half a century is at it’s lowest. The situation is similar in Europe with trust in social institutions (specially the political system) abyssmally low.
This is even more striking when we consider the emergence of the sharing economy — where we are ok to trust strangers. So, it seems that a defining characteristic of our times is that individuals no longer trust the social institutions which govern public life but are ok to trust strangers.
To be sure the sharing economy is enabled by web based platforms (e.g. airbnb) which intermediate transactions among strangers by establishing identity, building reputation and thus creating trust. The next step in this journey is likely to be enabled by blockchain based solutions. If you forget the hype (and the challenges) for a minute, blockchains are fundamentally a trust machine : they enable transactions among entities without requiring that the entities trust each other and without requiring an intermediary. In geek speak, this is called decentralization. In uber geek speak, this is called crypto-economics because the trust among strangers is ensured using cryptography. So, here is a question:
Can we extrapolate the decentralization philosophy beyond the economy to our social institutions?
What would these decentralized social institutions look like? Interestingly, nature provides us with examples. Ants, bees and wasps are living examples of how individuals come together and co-operate to form societies working completely in a decentralized fashion. Can we learn from these societies? It is worth noting that these insect societies are organized along family lines: each individual in the colony is a sibling and their co-operative behavior is biologically programmed. In human societies too, cooperation first emerged at the family level: hunter gatherer societies were predominantly aligned along family lines. As human societies grew larger, denser and more interconnected, we created social institutions to shape human behavior and achieve a greater expanse of cooperation.
Informal institutions like family and neighborhood set expectations of behavior and reinforce it by rewarding compliance and penalizing deviation. Social norms emerge out of the need to ensure stability & predictability by encouraging behavioral patterns which have been successful in the past. These behavioral norms evolve when individuals challenge status quo: when a behavior is beneficial to the individual and acceptable to the rest, it spreads in the population and becomes a social norm. Cultural evolution depends on the adoption of a behavior by individuals & the corresponding of others to this.
Formal institutions like the judiciary too set expectations of behavior (laws) and reinforce it by penalizing deviation. The relationship between the individuals and the nation-state that legislates and enforces these social norms (laws) can thus be considered a social contract: an individual accepts to follow the laws (social norms) in return for the guarantee that others will follow them too or rather the nation state will ensure that others will follow the laws too. Social norms (e.g. laws) set by formal institutions evolve through a more formal process of legislation.
Blockchains enable the emergence of a new class of institutions. Institutions which can be enforced in a decentralized fashion, are completely transparent in their functioning and can be consciously evolved by the democratic participation of the group members.
To design these institutions, we must go back to a more fundamental definition of institutions. In the most concrete interpretation, institutions refer to organization structures that govern our social life (e.g. governments, judiciary, markets etc.). At a slightly more abstract level, institutions can be thought of as rules which shape individual behavior — an interpretation that helps analyze the aggregate behavior of individuals and aids the design of new institutions based on fundamental desiderata. Finally, institutions are information systems — an interpretation which highlights the importance of decentralization for institutions to scale and adapt.
Institutions as Information Processing Systems: Let’s try and interpret the economy as an information processing system. In this view, both free market capitalism and state controlled communism are viewed as competing information processing systems. Capitalism uses decentralized processing — producers & consumers connect directly with each other, exchange information and make decisions independently. On the other hand, communism relies on centralized processing — where decision making is centralized and therefore information must be centralized too. Friedrich Hayek, one of the first economists to view the economy as an information processing system identified the key weakness of communism: not only did communism fail to provide an incentive to work hard, it forced signals connecting supply and demand to travel a tortuous path that invited distortion. This view has more recently also been discussed by others.
With the economy viewed as an information system, money becomes the key information technology — one that enables the flow of information by enabling trade to scale way beyond barter systems; by offering a standard of value in which prices can be interpreted; and by becoming a store of value in which credit and debt can be recorded.
Now, let’s try and interpret political structures as information processing systems. Democracies and dictatorships are, in this view, competing mechanisms for gathering and aggregating information (preferences). Dictatorships use centralized information processing whereas democracies use distributed processing. In general, distributed information processing systems scale better than centralized ones.
With democratic political structures viewed as an information processing system, votes become the key information technology — one that enables the flow of information by enabling citizens to express their preference and hold the elected representatives accountable. We can also view votes as a currency albeit one whose availability and frequency of use is severely constrained: modern democracies invariably grant 1-vote to 1-citizen once every 4–5 years. It is not surprising thus that today’s democratic structures cannot collect & process the information fast enough and ordinary voters are beginning to sense that the democratic social institutions do not really empower them.
What blockchains enable is viewing money or votes as a type of currency and hence an information technology. With this view, different currencies can be used to collect and aggregate information about the preferences, opinions and evaluations of a group of individuals. By enabling the creation of cryptocurrencies on demand, blockchains effectively allow the economics of markets to be extended to new domains.
Institutions as Mechanisms (Rules of the Game): At the most fundamental level, institutions are mechanisms which create and enforce rules of behavior. In Game Theory, Mechanism Design entails designing rules (games) which rational agents play to achieve a desired outcome. The literature in this space reveals fascinating insights about how the “rules of the game” impact the interaction among individuals.
Consider for example the Dictator Game which is played between two players: Alice & Bob. The rules of the game are set-up as follows: Alice is given $100: she can donate any part of this $100 to Bob and keep the rest. Once done, Alice and Bob can go home with the respective amounts. Empirical studies around the world have shown that, on average, people offer between $15-$25 to the other player.
Now, consider Ultimatum Game which is also played between two players: Alice & Bob. The rules of the game are set-up as follows: Alice is given $100: she can offer any part of this $100 to Bob. If Bob accepts Alice’s offer, both of them keep their shares and go home. If, however, Bob rejects Alice’s offer, neither of them get anything. Empirical studies around the world have shown that, on average, people offer between $40-$50 to the other player. Significantly, the behavior of people changes depending on the rules of the game: what players consider a “fair” offer changes as the rules of the game change.
Consider finally the Public Good Game which too is played between Alice & Bob. In this game, both Alice & Bob are given $50. Both of them are also given the choice of putting any part of their respective $50 into a common pool. Once they are done, the game organizer will double the money in the common pool and split it equally between the two players. The outcome which benefits both the players the most requires both Alice and Bob to trust each other, co-operate and put in $50 each. However, each player also has an incentive to exploit the other player by not contributing (freeriding). Empirical studies have shown that when this game is played repeatedly over time, on average, 50% of players condition their co-operation (contribution) on the co-operation (contribution) of the other player(s) and 30% free-ride (never contribute).
These simple games and how we play them reveal interesting insights about human behavior. They also underline how rules impact behavior. If we interpret institutions as rules which shape individual behavior, we can then design these rules (mechanisms). This is the domain of Mechanism Design:
“(In mechanism design) we begin by identifying our desired outcome or social goal. We then ask whether or not an appropriate institution (mechanism) could be designed to attain the goal. The part of mechanism design, called implementation theory, which, given a social goal, characterizes when we can design a mechanism whose predicted outcome (i.e. the set of equilibrium outcomes) coincide with the desirable outcomes, according to that goal”
- Maskin, Eric (2007), Nobel Prize Lecture
Smart Contracts as Institutions: This approach of designing mechanisms from bottom-up makes the challenge of creating new institutions tractable. We need not just limit social institutions to market or state. Any set of rules which incentivizes individual behavior can form the basis of an institution.
“The market was seen as the optimal institution for the production and exchange of private goods. For non-private goods, on the other hand, one needed the government to impose rules and taxes to force self-interested individuals to contribute necessary resources and refrain from self-seeking activities … Scholars are slowly shifting from positing simple systems to using more complex frameworks, theories, and models to understand the diversity of puzzles and problems facing humans interacting in contemporary societies.”
- Ostrom, Ellenor (2009), Nobel Prize Lecture
What blockchains enable is a ready platform for creating institutions. These institutions can be tried, tested, adapted — and finally adopted at scale if they are beneficial.
At the heart of this philosophy are smart contracts. Blockchain-based smart contracts are contracts that can be partially or fully executed or enforced without human intervention. Such contracts can be created using a programming language like Solidity and specify the rules of interaction among individuals for e.g. the rules may specify under what conditions will a currency be debited from one individual’s account and credited to anothers. If the currency has value, smart contracts can be used to incentivise behavior in individuals: in this, they act as institutions.
By encoding the rules of behavior and by ensuring that the execution cannot be stopped or manipulated, Smart Contracts enable groups of individual to co-ordinate and cooperate their behavior without the need to trust each other and without an intermediary. Thus, a fundamental characteristic of institutions realized using smart contracts is that they can be implicitly trusted. The trust is implicit in that the interaction terms are formalized in a smart contract deployed on a blockchain. Given the lack of trust in today’s social institutions, are social interactions intermediated by smart contracts a solution? At koinearth, we are fascinated by one simple idea:
Can social institutions be realized as smart social contracts on blockchain?
Can smart contracts be used to specify these rules among citizens and elected representatives? Among members of a community? Among anonymous users in a virtual community? Among intelligent machines? I feel these are the challenges and oppotrunities that we need to talk about as a community. There is a long way to go. We are just getting started…
We are at the very beginning of time for the human race. It is not unreasonable that we grapple with problems. But there are tens of thousands of years in the future. Our responsibility is to do what we can, learn what we can, improve the solutions, and pass them on.
- Richard Feynman
