I am as guilty as anybody at enjoying the Ether price rise. I returned to this field, my second love really (after VR). Crypto dominated my 1990s and led to the abrupt change of direction after my stint in the e-gold ecosystem turned conspiratorial and (potentially) dangerous. I backed away, but I always hankered for the unregulated world of free financial transactions, trust networks, and all the rest. This is all before the age of decentralization, it’s in the very first phases. You have decentralization because the e-gold economy got nuked and its LAMP stack centralized architecture, currency servers in an office and vaults full of $100,000 gold bars and somebody in that ecosystem probably funded the development of bitcoin to ensure that it could never happen again.

I may even have met Satoshi. I would never know.

I’ve had to rethink my old stance, that freedom of transaction created a fair, level playing field, after seeing the DAO. The issue is this, very simply: irrational investor behavior can be gamed, and there are people who know this and make a living doing it. By doing the equivalent of yelling “FIRE!” in a crowded theatre, and then charging $5 for an exit ticket, they take advantage of predictable consumer behavior to drive destructive harvesting of value. The DAO’s real problem isn’t the hack — that is certainly a problem, but it’s not The Problem.

The Problem is that there is asymmetric information between the people who understand consumer behavior really, really well, and the consumers. The people who know how the game is played are playing directly against people who have very limited experience and information resources to manage their risk, so the “level playing field” is actually a meritocratic shooting gallery.

Those with more experience and better bets have unrestricted access to the ordinary people who have little incentive or capability to resist systemic farming of their value. You would think that (for example) union-like structures might form among small investors to provide them with a united front against systemic farming but, in fact, the desire to have a little more savvy than your neighbours in playing the markets makes it very difficult to find the required political unity to manage risks appropriately. This is analogous to the situation in the music industry where established artists tend not to bankroll new artists because they compete for the same listeners, whereas established technologists spend a lot of time investing in young technologists because their own skills are largely obsolete, but they can spot a bright young thing and facilitate their advancement at minimal cost. Tech has solidarity because old techies and young techies don’t really compete for the same air and this is one of the great strengths of our field.

So I want to propose a paradox. In creating a level playing field with fair competition, we actually create an unfair field, in which those with greater skill and experience are given direct access to the mind-state of people without much to protect them in terms of market savvy. This is not like buying Manhattan for a string of beads, but it’s a systemic inequality based on market dynamics which individuals have little control over. Those with assets and skills are forced to prey predate because they can, and those without assets and skills struggle to try and find an edge to pull themselves up by their bootstraps by (for example) day trading. The entire domain is beset by this paradox: a more egalitarian world by creating a “level playing field” between people with PhDs in economics, and people fresh out of high school sinking their inheritances into cryptocurrencies. This kind of competition is what regulators in the mainstream financial system struggle to regulate: how do we prevent experts taking advantage of novices in a way which results in an overall loss of value — a tax on ignorance — which harms the economy much like any other form of regressive taxation would. We ban this stuff in the regular economy not just because it is bad for individuals, but because it is bad for society as a whole: Scotland unified with England partly because of the enormous financial losses from the Darien Scheme. After the South Sea Bubble popped, the UK government banned the sale of shares for three generations.

The entire history of finance is the history of large groups of people responding to the prospect of money-for-nothing gain in the same way that their bodies respond to refined sugar.

We have little or no defense against this kind of risk appetite because we are, after all, simply evolved beings with limited ability to respond to threats which our ancestors rarely if ever faced. Finance has not been round long enough for people to become genetically resistant to promises of extreme rewards, but our individual appetite for risk is clearly conditioned by our own individual genetic disposability. As long as enough of our genes go on in relatives and other close kin, a one-in-a-hundred chance of getting eaten by a bear is the price of admission to the lucky fellow with heavy resources lotteries. We take risks because it pays better than safety, and because on the evolutionary baseline that we evolved on, all individuals are completely expendable. Doubly so for young men, as a visit to any emergency room around a major partying holiday will show you. So we have an industry dominated by young men with a super high tolerance for risk, many of whom have been out to the races twice: once with bitcoin, and second time with Ether: wealth doubled and redoubled five or six times as people rode the innovation curve up.

Now, I’m not arguing that Bitcoin or Ether are over-priced. This is not an argument against the enormous potential of blockchain technologies to solve very real world problems in ways which may well generate completely new classes of wealth generation. A near-frictionless transactional economy with securely automated trustless escrow, non-repudiable payments and the rest of the powers which come with smart contracts can hardly fail to generate enormous earnings as it streamlines the 7% margins taken by all manner of middle men into a more realistic 0.07% margin. No doubt this is good for all, and on top of that, the real wealth generation comes when the reduced friction in the economy simply results in entirely new classes of business models which require an ultra low friction substrate to be possible. Having payments flow through 100 hands now will consume nearly all of the payment in the current economy, but in a smart contract ecosystem it may as well be free. In fact, it might well be actually free other than hair thin transaction fees which look more like web hosting bills (i.e. a few dollars a year) rather than 0.5% of your transaction.

But those fat middle men are regulator’s best friends. They are making so much money as gatekeepers for payments charging for use of their rails that they can be saddled with onerous duties such as regulation and compliance, Know Your Customer and Anti Money Laundering, and while these duties are horrendously annoying, none the less they have deep enough pockets that they can carry the costs, and pass anything that they cannot handle on to the supine consumer, who has few alternatives.

High transaction costs are paying for governance of the existing financial system. Very, very weird things happen when these transaction costs, and the muscle which allows for regulation to be imposed on these transactions, goes towards zero.

The DAO hack is just the beginning of a whole new era of discovery of what the actual functions are of the current regulated financial system: all those layers of parasites and symbiotes, the baroque circles of back scratching and insider information sharing, all the collusion and conspiracy we have come to associate with the world’s bigger financial centres… all of this is about to be rediscovered or, through their own adoption of blockchain technology, laid bare.

We are in a position where we are rediscovering the need for regulation more or less from first principles as we stagger forwards, drunk, at a quarter of the speed of light into a future which none of us sees as clearly as Charlie Stross did in Accelerando! We are in science fictional times, with our financial superconductors offering the prospect of resistance-free financial assemblages to solve the world’s problems, or create entirely new ones. Who’ll be the first person to crowdfund a war, or crowdsource a revolution; we will see these people, you and I. In fact we may well be them, dear reader. It might be us that pulls the trigger on social transformations beyond imagining, as frictionless technology brings “hubless AirBnB” to every open space for a human to sleep, and the same for offices, cars, and every other place where we underutilize a product or service in a way that ultra low transaction cost markets could open up as a recoverable resource on our increasingly crowded planet.

Seductive and terrifying, our blockchain future is inevitable. Or is it?

I was horrified by my reaction to The DAO. I still haven’t gotten over it. Like many people, I watched money pouring into The DAO far, far past what I considered to be a safe or appropriate limit, yet in a decentralized system there was no mechanism by which the trouble which might be caused by the rise would be forestalled. Without systemic incentives, both carrot and stick, to spur individual or collective action to sound the alarm, far too little public doubt was expressed. Without a secure division of labour between those profiting from the system, and those whose job it is to watch the system, how can stability be assured? We know from history that these faults are not self-correcting, that in fact meta-structures are required to ensure that these markets remain even semi-functional, rather than being explosive decompression engines for value in society. We all know the political trouble that financial collapses cause, and how regular they have been throughout history.

Why should our situation be any different?

We are in a position where we have discovered a basic governance gap in our ecosystem. Nothing in the ecosystem stiffened the spines of the experienced players who knew we were outside of the safe flight envelope in time for us to protect the rest of the ecosystem by speaking out with a united front, taking the hit that we would have taken both personally and professionally for calling for a stoppage, and providing the shield of collective responsibility to those actors. There was a moratorium call. There were analysis of the DAO’s risks. But there was nothing with enough (ironically) authority and weight to call a halt, and here is where I find my crisis.

Was the only way to prevent irrational investor behavior pulling the entire Ethereum enterprise into danger to recreate a government?

Casino capitalism is no joke. The reliably incredibly self-destructive behavior of investors confronted with a small chance of enormous gains (or, even worse, a Sure Thing) is as toxic as heroin and, when indulged in with a fair percentage of society’s assets, as dangerous as war (which it it all too often starts.) The Darien Scheme in Scotland in the 1690s had pulled in more than 25% of all the money in Scotland. The DAO pulled in 12% of the Ether. Nearly everybody in the ecosystem had an opinion on it, many or most of them had at least considered buying tokens, and it was a major focus of conversation the entire way through its meteoric rise and fall. It is not that nobody was paying attention, but rather than we could not organize that attention into the required due diligence and authoritative, protective voice required to prevent our self-organized little society from blowing itself up on the same rocks which have claimed so many of our previous efforts at large scale social self-organization. Markets explode. It’s what they do. So where does this leave us?

Into the governance void left by the evolution of the DAO must step a force. It might be a renewed effort by the Ethereum Foundation to provide advisory notices on security and policy. It might be a viciously precise panel of third party auditors and risk assessors that we pay for on a voluntary basis to monitor our ecosystem health and stand down efforts which look to destabilize our world or put undue amounts of user value into jeopardy without a corresponding hope of return. It might be a consumer’s union for cryptofinance which insists on professional standards for innovations so that ordinary people will be protected in the face of combined technological and financial sophistication which they cannot hope to navigate without systemic error. It could be a set of arbitrators operating from open source standards for Ricardian smart contracts.

But, whatever it is, it has to fill the void which the DAO fell through. As I said in a video I made shortly after this whole process got started, many, many things have to go wrong before a genuinely bad engineering accident happens: layers and layers of safeguards have to malfunction, attention has to be elsewhere on the critical day, people overstretched and over-extended make predictable errors. A problem of this size is not born of less than five or more parents, regardless of how simple the tabloid explanations of the situation will be at the end of the day.

Our transcendent solution to the DAO problem, should we choose to embrace it, is to ensure that the DAO’s problems never re-occur. That’s not a question of auditing smart contracts: the problems could have been just this bad in a ponzi scheme or a wild game gone completely wrong. It’s not a question of user education: most critically, if we continue to grow rapidly, there will always be a majority of users in the system that were not around for the last disaster and so constitute virgin territory for scams and schemes and psychos to expand their influence without the resistance which comes of prior experience. Ironically, our own growth is what makes us vulnerable to exploitation as wave after wave of new users have to learn that hard way that there are bears at the top of this particular salmon run. Thwack!

Can a fully decentralized system provide the kind of governing authority required to inform new users that they are in danger from something which must be ok because, hey, 12% of the value in the entire smart contract ecosystem can’t be wrong?

I don’t know. But that’s the challenge that we have to face if we are going to provide a safe place to do business to the next ten million Ether users. MetaMask and Mist are about to hugely expand the reach of our ecosystem and it’s up to us to design the mechanisms to provide them with trust, safety and enduring, lasting prosperity if we’re going to be an integral part of the future. I don’t know if we are up to that challenge, but I think the indications are good. There’s been plenty of discussion over the years about how to construct review schemes for smart contracts so that users know exactly what they are sending value to. Tiers of inspectors and insurers, bonds and all manner of other mechanisms have been suggested and specced out.

The only answer to “who watches the watchmen” which is compatible with the functioning of a fair and just society is “we all do.” This is the political solution required to the governance crisis created by the DAO: we need collective action on security and transactional integrity equal to and greater than the risk created by the enormous decentralized organizational power of collective action that smart contracts create: we must govern our risks at the same level of skill and power with which we create our opportunities.

It may take a few years to get this right, but nothing should be allowed to grow too big to fail in the meantime. I don’t know how to enforce that simple piece of common sense, particularly given the problem that in a year only 20% of Ethereum users will ever have heard of the DAO if the number of Ethereum users grows in the sort of ways that I expect, particularly if smart contracts wind up embedded deep in the heart of consumer-facing ecosystems in music, social networks and other areas with massive public appeal. Our very growth makes us vulnerable to generation after generation of problems, and it’s only the creation of strong systems of institutional memory and collective defense that can protect the ecosystem from these naturally arising phenomena.

We have a metabolism. It is now time to construct our immune system. I look forward to working with you all on this.