Web3: Procedures vs. Contracts
Summary for blockchain people
We can make Web3 useful to a wide range of businesses by abstracting strings of smart contracts into an interface that lets normal, centralized businesses replace legal agreements with DAO-like procedures. Doing so would make the most powerful parts of the blockchain ecosystem accessible too many more organizations.
Summary for everyone else
I propose that we use Web3 (defined above) to help businesses move away from using legal contracts and towards what I call “procedures.” For example, with traditional contracts, a contractor has to hope that the business follows its agreement to pay her invoice and must go to court when it doesn’t. Instead, we should connect computer programs, running on the blockchain, to the business’ income source on one side and to the contractor’s account on the other. The program automatically allocates the money as it arrives, and can only be re-programed with the approval of both the business and the contractor (Blockchain is what makes this last part possible).
Terms I use
Web3: a way of describing the category of applications that blockchain technology makes possible.
DAO: A “Decentralized Autonomous Organization,” is an organization in which the decision-making process is controlled by a software program. No single group or individual can edit the software without following the pre-defined process for doing so.
Disclaimer: These ideas are still a work-in-progress (otherwise they wouldn’t be fun), so I have placed “Questions For The Audience” (calls for criticism, input, and ideas) throughout the post. I would love to hear what you think.
Lets get into it
This post contributes to the general weeping and gnashing of teeth surrounding the question “but how is Web3 actually useful?” The proposed answers tend to coalesce around:
- cross-border and censorship-resistant movement/management of money,
- forms of certification without a central authority, and
- fairer compensation for artistic production.
The first two will be the subject of later posts. The third, tools for creatives, has become a very hot subject over the past year, and it’s a useful starting point for our discussion because it is where we see people creating solutions that are simple and self-contained enough to become products and services.
Question for the audience: Are my categories correct? What is missing?
Web3 for Artists
The third category has focused so heavily on artists because of technical limitations to providing value elsewhere. The crypto ecosystem is generally isolated from the rest of the economy because there isn’t any way for a blockchain to keep promises relating to off-chain value. For example, no smart contract can ensure that Anne pays Bob 25% of her income unless Anne’s employer, the one paying Anne’s income, chooses to convert Anne’s wage to a cryptocurrency and send it to the smart contract’s address. Needless to say, most employers aren’t set up for that sort of thing.
Creative industries offer two paths around this problem. The first is to produce digital content (like CryptoPunks) and distribute it on-chain from the start (OpenSea, Foundation, etc.). The second is imbuing tokens with certain benefits and privileges like the ability to access a private Discord channel or advance ticket sales (Coinvise, MintGate, Rally, Juicebox). This works because the value art creates is based entirely on its engagement with an audience. Not so for SaaS products, or appliance brands, or mining companies, which offer utilitarian value. Very few people would participate in a Bosch token sale in order to get occasional discounts on washing machines.
Note: Games enjoy the privilege of being able to leverage both of the paths described above. Not only does their value come from engaging players, but they can also create markets between their players, on-chain, from the start.
Question for the audience: How else are artists using Web3? Are there additional models relevant to this analysis?
The exceptions to the dynamic described above offer clues regarding how to build universally useful business tools out of blockchain tech. Take, for example, services that allow musicians to share revenue with fans who purchase a token linked to a particular piece of content. This is possible because streaming platforms like Spotify rely on third party distributors to submit content and pay the artist. By serving as one of these third parties, Web3 companies have the ability to send the artists revenue to the NFT holders as promised. This, from what I can tell, is how Royal and CreateSafe work.
We can generalize this concept by describing it in two parts:
- The Anchor: a mechanism for moving an off-chain asset — in this case streaming revenue — on-chain, and
- The Procedure: a programable distribution mechanism.
It is important to note that The Procedure is the value proposition, which The Anchor facilitates.
Question for the audience: Does anyone know for sure how Royal gives token holders rights to revenue? Is there a legal contractual aspect to it?
A New(ish) Agreement Paradigm
We propose using blockchain to create a new, more efficient, and more flexible approach to common business agreements, much in the same way DAOs already do.
From describing rights to upholding a process
Traditional agreements — legal contracts — are designed to be enforced by a third party during a dispute event, and therefore focus on describing each party’s rights.
Procedures by contrast, can be enforced continuously: they do not position the parties to adjudicate disputes, but instead, uphold a process. They do not describe the parties’ rights, but rather, the parties’ powers in the process. For example, a project could manage revenue according to “flows” that creators configure up-front. They could then establish a procedure that gives team members the ability to vote on any proposed changes to those flows. This allows flexibility while protecting members’ interests.
Note: This kind of fund management is already common in Decentralized Autonomous Organizations (DAOs). We are proposing that organizations that aren’t decentralized or autonomous should still use procedures. Doing so will not only make them more efficient, but will also contribute to the value of DAOs by giving them more ways to interact with regular organizations programmatically.
Question: When should an organization be decentralized and when should it not?
- This approach to agreements does not rely on third-party adjudication and is therefore more suited to teams that want to get to work quickly, across borders, and without reliance on national court systems. Say, for example, that a team wants to make sure the person paying tokens can’t cheat collaborators by sending tokens to herself. A procedure could require a majority of current token-holders to approve payments to any new wallet address, giving them the power to prevent the creator from making herself a token recipient. A traditional legal contract, by contrast, doesn’t have this built-in enforcement. The collaborators would therefore have to take the creator to court, possibly in a foreign jurisdiction, if they suspect her of violating their agreement.
- Procedures, unlike traditional contracts, do not have to anticipate all the potential future outcomes of the relationship. Instead they specify what powers the parties will have to address those outcomes when they emerge. For example: our creator from the previous example may discover that she needs to set up another recipient wallet to cover expenses, and a majority of current token-holders could choose to approve it.
- Procedures for issuing and allocating revenue tokens
- Procedures for allowing creator to increase a cap on the total number of tokens
- Procedures for changing allocation for expenses
Question for the audience: Please share your ideas for other use-cases!
Anchors facilitate Procedures
Procedures only work if the assets they manage are on-chain, and as we know, most business assets are not. We therefore must connect the chain to the off-chain asset (or liability). We call this mechanism an “anchor” and we can judge its quality using the following parameters:
- Simplicity & Transparency: Anchors should be as concise, narrow, and simple as possible. They should be easy for participants to understand and trivial to maintain.
- Automation: The best anchors move assets and liabilities on-chain automatically.
- Trustability & Predictability: The traditional economy is run by centralized parties, so getting assets from that economy on-chain will usually be a centralized activity.
- Coverage: Ideally, it is impossible for any party to route value around the anchor. It would be destructive, for example, if a game studio could avoid its obligations to contributors simply by publishing content to a marketplace that directs revenue somewhere other than the studio’s smart contract. This sometimes means relying on, or at least backing, an anchor with a legal contract a court can enforce.
Question for the audience: How could we decentralize anchors for things like moving a business’s revenue on-chain? Put another way, how could we make sure all of a business’s revenue arrives on-chain without having to trust any individual party to make sure that has happened?
Note: at Cooperativ, we are working to build two-layered anchors. The first layer being automation/integration that makes it easy to move revenue on-chain, and the second layer being a legal contract that gives contributors a fallback option in the event that a project tries to route revenue around the automated mechanism.
Putting This Into Practice
Our first experiment with this model was Contributor Credits. The idea was to provide users a way to issue tokens tied to a legal obligation. We considered exactly how the legal language should reference the smart contract, and how the smart contract should reference the legal language. Like social tokens, Contributor Credits represent a promise. Unlike social tokens, that promise represents a claim on off-chain assets and is backed by a legal contract.
Fairmint.io and Tokensoft.io have both built great products on a similar model. They let the customers define the terms of equity in a (court enforceable) legal document, then manage that equity using standard Ethereum tokens. Any company can use these products to make selling and managing equity efficient and programatic.
Question for the audience: If you know of other examples of companies who are using a hybrid of law and blockchain, please share!
Contributor Credits, Fairmint tokens, and Tokensoft tokens are anchors — tokenized off-chain assets — backed only by a legal obligation. Fairmint is the farthest along in the development of useful procedures. They allow their customers to program price curves for tokens (automatically increase the price as investors buy up the tokens), which they can issue into a pool of pre-vetted investors. It’s a way of maximizing high-resolution fundraising programmatically (brilliant!).
But this barely scratches the service of what’s possible with procedures. Unleash their potential, we need to innovate in the following areas:
- Anchor construction: much can be done to optimize for the parameters described above. Integrations and payment processing services are rich veins to explore.
- Procedure creation interfaces: we are putting a lot of time into researching the clearest UX for describing how money and assets should flow through an organization, and most importantly, on for describing procedures for changing that flow.
- Making wallets optional: wallets are fantastic for allowing people direct custody over their assets, but some users will not want or need that, and it should be possible for them to participate in procedures as well. At the same time, it should be natural for other users to use wallets.
Question for the audience: What else is holding this approach back?
… the end
This post was written by Jake Chase-Lubitz, the founder of Cooperativ Labs. You can find him on Twitter.
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