The internet grew quietly in obscurity and then exploded into the public consciousness in the late 90s. The emergence of the blockchain from the shadows of tech bulletin boards to the limelight on the front page of Forbes has been even more dramatic. 2017 has been the year of the blockchain. Everyone has heard it but few know what it means. Everybody thinks that this revolution will bring enormous changes.
The atmosphere is ripe for hype. Everywhere computer experts that were simple programmers have now become “blockchain experts” overnight and countless startups have incorporated the term into their company name with the objective of attracting investors. Adding “bitcoin” or “blockchain” or “crypto” to a name when the project does not rely on these technologies is a bit like adding .com to your name back in the 90s, a practice denounced in a warning from SEC Chairman Jay Clayton.
What Is The Blockchain?
A blockchain is a type of database, a way to store information. It is a continuously updated list of records, called blocks, that are linked and secured using cryptography. Recent articles have created a widespread perception that blockchain can make financial transactions more efficient, cheap, and fast.
A blockchain is different from a single database because of it’s “high Byzantine fault tolerance.” That means even when one of its servers appears to some observers to be broken but other observers believe the server is still working, the system continues to deliver good results. Since its implementation in the version widely known as Bitcoin, created by the inventor Satoshi Nakamoto, blockchain has aimed to eliminate the “man in the middle.” For this purpose it is perfectly effective, but not efficient.
The Blockchain Is Secure But Inefficient
Blockchain technology is inefficient by design. In order to eliminate the problem that the failure of a single point causes system failure, blockchain replicates every point. This provides very robust reliability but it is very inefficient.
The slow speed dictated by the timestamp and the need to use a network with enormous computing power to maintain its security is not as efficient as a single central processor. For this reason, keeping a blockchain network active and protected is very expensive. To solve this problem, as in the case of cryptocurrencies, those who keep the network safe must necessarily be rewarded with the currency itself in the form of mining fees.
Since using the blockchain introduces inefficiency, we should study each potential application and ensure the blockchain is really helping to solve some problem. Certainly if having the security of highest possible fault tolerance is necessary, the blockchain represents today the best possible solution.
Smart Contracts Harness The Power Of Blockchain
Ethereum is a successful use case for the decentralized platform concept. Ethereum has grown very rapidly because it offers the ability to run smart contracts, a computer protocol intended to facilitate digitally, verify, or enforce the negotiation or performance of a contract without third parties.
The main advantage of smart contracts is that they are automatic (what happens in the contract will be executed), fast (in the case of Ethereum are executed in a few minutes), direct (there are no third parties) and transparent as all data are recorded on the blockchain. They also have very low costs. Businesses have only recently begun to use smart contracts. Currently, the majority of smart contracts are used to service purchases.
Could smart contracts on the blockchain be used for more complex deals?
Smart contracts could save a lot of trouble if they could be used for deals where currently available dispute resolution alternatives are often neither quick nor efficient. Of course, that applies to most deals. The legal systems for contract enforcement are localized and byzantine, largely ineffective for small players, slow and costly for large ones, and ill-suited for international deal making.
Better Dispute Resolution Is Needed
Every day, in a truly global marketplace, millions of decision makers must decide whether or not to enter into agreements knowing that they will be costly to enforce if they are broken. Some will decline to act, knowing they cannot depend on an agreement. Others will enter into agreements that will ultimately be broken, leaving them to choose between pursuing costly and slow enforcement, perhaps in a foreign jurisdiction, or surrendering to injustice.
Particularly for small business, or larger businesses that have many agreements for small sums, the cost of enforcing a broken agreement can exceed the amount in dispute. In addition to those broadly defined “direct” costs, inefficient dispute resolution imposes even larger indirect costs. As the OECD has noted, unreliable, slow, and costly dispute resolution stifles economic activity. Partners who cannot trust each other cannot plan and operate as efficiently as partners who are confident that agreements will be followed. While in our opinion, the project of estimating these costs is too complex to result in a confident answer, we believe we can be sure that they are immense.
The market for dispute resolution is enormous. Government courts and formal arbitration systems currently serve most of the market, along with several other solutions serving niche markets. Government and arbitration are costly and slow; alternatives have their own limitations. For many small contracts, no viable enforcement mechanism exists. Disputes for some small contracts can be resolved with niche solutions, but these are limited in applicability and have shortcomings even when they can be used.
Pros and Cons of Current Dispute Resolution
Let’s now evaluate the pros and cons of current and future dispute resolution systems, alternative dispute resolution systems, third-party guarantee systems and finally, smart contracts. In general, traditional dispute resolution (also known as ADR) should be seen not as something that can replace traditional litigation but as a tool that can assist courts in resolving disputes in a timely, cost-effective and transparent way. ADR mechanisms can improve efficiency in the court system as a whole by helping to reduce case backlogs and bottlenecks.
Traditional ADRs (mediators or conciliators and arbitrations) can be divided into two categories. On the one hand, mediation or conciliation: they are voluntary instruments (not compulsory), so the parties spontaneously choose to ask for help from someone who helps them resolve their differences. As a rule, the mediator or conciliator does not offer enforcement of any kind if one of the parties refused to abide by their ruling. Arbitrators, on the other hand, render binding decisions that can be enforced by civil authorities. Usually arbitration is specified in the initial contract. It is often very expensive and therefore inaccessible for those contracts involving small and medium enterprises.
They can be a good solution in some cases but mediators do not offer an enforcement mechanism, so they are only effective where there is adequate good faith. Also, arbitration tribunals are very expensive and therefore unsuitable for small or medium-sized contracts. Enforcement of an arbitration award can require intervention by the public authorities, which takes time.
Another commonly used method for basic dispute resolution is the use of third-party guarantee systems like Online or Offline Escrow Systems, Bank’s Letters of Credit. Entities entering into agreements that involve payments can deposit money with a third party who agrees to hold it and release it when certain conditions are met. The conditions are verified by third parties like Escrow.co, an online escrow platform. These services have high fees, they are not flexible in operating structure, and they can only be used for specific categories of contract unless a very large sum is involved. They also have the problem of a centralized system of dispute resolution: you do not have any choice in who will rule on your dispute.
Smart Contracts For Dispute Resolution
So why not use smart contracts for dispute resolution?
With a smart contract we can reduce the costs of legal complexity greatly by offering users to choose an environment with a framework of rules that offers just the right amount of complexity- not to little, not too much.
With a simple smart contract, there are no rules other than your own idea of what the majority will believe is fair. This method will not work for every agreement. For some agreements and disputes, complexity is required, not unnecessary.A simple system of smart contracts cannot provide reliable dispute resolution for complex agreements. But smart contracts could be supported by additional frameworks for interpreting contracts and resolving disputes that require additional complexity.
For many agreements, smart contracts can eliminate complexity altogether and for many more, a simple framework can provide just the right amount of complexity, making lower cost dispute resolution possible. This will eliminate the direct and indirect costs of complexity for suitable agreements, and reduce disputes.
Who will act in bad faith, knowing fair free dispute resolution is sure to come swiftly? In this way, smart contracts can save hundreds of billions of dollars of wasted effort.
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