BlockBytes|Byte 3| Contract Design & Smart Contracts
In Byte 1 I explored the basic formulation of current economic system and went to explain the transaction costs in each transaction we make as part of economic exchange in Byte 2. In this third installment I would be digging deeper into the basic construct of current contract design and how crypto-tech can help in reducing the transaction cost through Smart contract.
To refresh, transaction costs amounts to all the mental and computational effort ( either mechanical or done by computers ) in each economic exchange. Contracts since ages have always been done in Paper. The primary reason being static medium like paper makes duplication difficult. With advent to IT we got the capability to convert contracts designed for paper medium to be translated to electronic format. This dilutes the non-copy capability of contracts and yet brings about an interesting paradigm of getting these contracts dynamic and programmatic and hence bring about a drastic cost revolution in areas of jurisdiction, trust, and security.
Contract Design
Contracts designed by human minds and agreed upon by relevant stakeholders are directly implemented as is. Auditors break them into a set of data flow with associated checks and procedures called controls. A very old and widely used example of a control would be double book keeping, which makes sure that transaction will have entries in both side or not at all.
Controls enable auditing of contract performances, allowing more precise inference of the behavior of an agent. A complete control protocol typically features the generation of initial documentation, segregation of duties, and arithmetic reconciliation of quantities of goods, standard service events, and money.
However these controls are designed around static contracts on papers and often involve generation and exchange paper proof to leave paper trails for ex-post validations. This goes completely against the philosophical question of privacy.
Phases in Contract
Ex-Ante
Search
Negotiation
Commitment
Ex-Post
Performance
AdjudicationDimensions of Contracts
- Observe-ability : The ability of contracting parties to observe each other’s activities and make their performance of the contract visible to any other contracting intermediary. The primary motive is to make sure there are no adverse selection ( choosing of a wrong option due to lack of information during search phase )or moral hazard ( due to unavailability of information regarding contract performance ). Observe-ability by humans need easy consumable interfaces ( UI/Data).
- Online enforce-ability : It relates to either preventing or punishing breach, eavesdropping or interference by any party internal or external to the transaction. This is also asks questions related to building and enforcing new laws relevant to contract application rather than a laggard approach of checking the transaction trail data for search of any breach.
- Verify-ability by adjudicators : the ability of a principal to prove to an adjudicator that a contract has been performed or breached, or the ability of the adjudicator to find this out by other means. The disciplines of auditing and investigation roughly correspond with verification of contract performance.
- Privity : Privity is the principle that knowledge and control over the contents and performance of a contract should be distributed among parties only as much as is necessary for the performance of that contract. All contract execution should protected from all kinds of attack and influence by external third party , intermediaries.
Privity as principle goes against the nature of observability and adjudication. The more you need the later the more you will have to give up on the former.Hence the design philosophy for a smart contract
Smart Contracts
In smart contract design we want to get the most out of intermediaries and adjudicator, while minimizing exposure to them. One common outcome is that confidentiality is violated only in case of dispute.
This starts with a design of a new set of protocols which takes advantage of years in development and refinement of business specific physical controls and morphs them into “physics of cyberspace” i.e use of cryptographic tools. However cryptographic tools are have two limitations
- It depends upon the integrity of human who is in possession either the message to be encrypted or the key that decrypts it. The protocols is as long as humans dont pass on the information post decryption
- There is always an upper limit of safety. Even the most difficult to crack encryption algorithm is never unbreakable. They just make the process of cracking economically not feasible in current processing power.
Hence my favorite of all tools Multiparty Secure computation. Imagine a google sheet which as selective view of raw data made available to a group of participants. Now image each participant has a selective access to a few specific cell for data entry. Each data entry operates on raw data and spits out result relevant to respective party. No one sees what input went in. In this the only weak link is the google sheet which is the single point of failure. What if we have a decentralize virtual computer which is able to execute programmable contracts yet hold no data and relay relevant information to necessary participants.
Performance phase (of contracts) analysis with multiparty secure computer theory would seem to apply only to those contracts which can be performed inside the virtual computer. But the use of post-unforgeable auditing logs(current blockchains), combined with running auditing protocols inside the shared virtual computer, allows a wide variety of performances outside the virtual computer to at least be observed and verified by selected arbitrators, albeit not proactively self-enforced.
One of the forefront in Smart contracts is Ethereum who have this programmatic approach to contracts during payments as an improvement to traditional Bitcoin framework. What excites me is the capacity of smart-contracts to disrupt enforcing costs of Transactions. In continuation of our discussion I will take dig at the Satoshi’s Bitcoin whitepaper and that of Ethereum.
Next Byte : Bitcoin and its siblings
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