Aaron Powell: Welcome to Free Thoughts. I’m Aaron Powell.

Trevor Burrus: And I’m Trevor Burrus.

Aaron Powell: Joining us news Kate Sills. She’s a software developer and researcher in the area of smart contracts. Welcome to Free Thoughts Kate.

Kate Sills: Well, thanks for having me.

Aaron Powell: What’s a smart contract?

Kate Sills: Yeah, so that’s a really good question and it’s actually a really contentious issue in the cryptocurrency community. So, let me start with what a smart contract is not. [00:00:30] Despite the name, a smart contract has nothing to do with artificial intelligence or machine learning or robotics or anything like that. A smart contract is actually just dumb code.

It’s also not a legally binding contract, which I think there’s a lot of people off. But what it is a way that people can create credible commitments with one another and you can do this with strangers even across the globe. It’s really revolutionary but I think the name itself, [00:01:00] like people have a tendency to view new technology in terms of old technology, so I call this the horseless carriage problem because when cars first came out, they were known as horseless carriages and I think people are doing the same thing with smart contracts. Just because of the name they’re comparing them to legal contracts but they’re not legally binding and they have a lot of differences than a legal contract.

Just like how a car solves the same problem as a carriage, [00:01:30] both legal contracts and smart contracts solve the problem of commitments. The original problem going back to like Thomas Hobbes in 1651 with Leviathan was how do you get people to actually keep their promises. How do you enforce that? Because he said words alone aren’t enough for you to force someone to keep their promises, you need some kind of coercive power over them both. So, it was assumed that [00:02:00] government was the way to do that but this is a way to do that without government coercion.

Trevor Burrus: So contracts to a lawyer means a promise that the government will enforce basically. It has to have these characteristics as people make promises like I promise to pick you up tomorrow and the distinction is that if I don’t you can get the government to either compensate or do something to say you reneged on this promise in a way that is unacceptable.

So you said contract is a wrong word for this. Do you have a word you prefer, [00:02:30] because I see this constantly in the blockchain world where the metaphors might as you said, if you have a difficulty here, even mining, that’s like a bad metaphor in its own way. Would there be some better way of calling them, do you think? Like are they itemized trustless agreement systems or something like that?

Kate Sills: Yeah. I like the word or I like the phrase self‐​enforcing commitments because I think that’s what they are. Once you release the code and it goes out to the blockchain, [00:03:00] it’s automatically enforced. And I think the commitment part really puts into perspective the importance of it. You’re able to make agreements with all of these different kinds of people even if you don’t personally know them, you don’t even know what the reputation is. And so, I like the term self‐​enforcing commitments.

Aaron Powell: What’s the relationship between smart contracts and blockchain? The notion that we could have contracts or contract like agreement written [00:03:30] in code could’ve existed, I mean as long as we’ve had code. But these always get talked about in the context of blockchain technology. So is there something about blockchain technology that enables these, these possible before?

Kate Sills: Yeah, yeah, that’s a really good point. Well, we’ve always had kind of an electronic version of contract. So there’s like EDI systems where the contract itself is encoded and businesses will exchange information that way. But what is really important about [00:04:00] smart contracts is that they’re enforced on the blockchain so they’re enforced by a consensus of your peers. So each computer that’s connected to this network is actually running that code. And if they don’t come to the same conclusion as all the other computers in the network then the consensus breaks down.

To me, the really special thing is that having something enforced by the consensus of your peers is something that we’ve never been able to do before, the opportunity costs have been too high to try to do that, right? [00:04:30] In the time of the founding fathers, if you were doing that you’d have to like you know send letters to everyone. It’s a technological issue that we’ve been able to overcome.

Trevor Burrus: Which I guess, kind of the letters thing reminds me of, because I read a lot about the founding, you go to a new city and someone like George Washington might give you a letter of introduction to take to someone that he knew in that city because you don’t have a reputation and that’s sort of the very, very basic way of [00:05:00] trying to get this kind of reputation economy as opposed to, all these people sent letters and said this person as is reputable and they all agreed on it and they did it very quickly which is kind of what the blockchain does.

When it comes to the blockchain from what I know about Bitcoin a cryptocurrencies you have this other proof of work issue where you have one computer try to solve a very difficult problem which makes it rare. Would that be a part of the smart contract [00:05:30] in the same way that it is for Bitcoin or ether as a currency for example?

Kate Sills: Yeah. So proof of work or proof of stake, they have multiple different ways of doing it but those are all ways to secure the system itself and then smart contracts work on top of that system. Let’s see, you can think of it as like, so when you’re trying to create a ledger that everyone agrees on, it’s almost like internet voting. The problem of internet voting is someone could just create [00:06:00] multiple accounts and be able to vote multiple times.

Trevor Burrus: Like every IMDB movie page.

Kate Sills: Yes. So you have huge problems with that. So the way that you cut that down is to make sure that there’s no way that someone can actually create multiple accounts very easily and the way to ensure that is to make them go through all of this work just to be able to have any say in the process. The system itself is secured by proof of work and then smart contracts are built on top of that. [00:06:30] So the code is run, so like the smallest smart contract is just a transaction. You’re just sending money from one account to another. But you can add conditions to that. So you could say, you know, only send this after a certain time and the money would sit in that smart contract until that time.

Trevor Burrus: Maybe that gets into more of the details that it would be upon x, the code would say upon when x happened then release the money. Is that the block, is that [00:07:00] part of, well the thing that would get into the blockchain or am I just, see this is, every time I talk about coding, Aaron knows more about coding than I do he’s just looking at me like I’m a crazy person because I don’t .… How does that actually become part of the block?

Kate Sills: So you have to write the code to the blockchain and that gets put into the blockchain by a miner or depending on what platform you’re in baker, whatever [00:07:30] they’re calling it. So one example of a smart contract might be like an options contract. That’s pretty easy to write in code. You would just say I am giving someone the option to buy this thing, maybe, you know, it’s a stock or what have you at a certain price by a certain time. So all of that logic can be encoded pretty simply.

Aaron Powell: So we typically hear about these [00:08:00] within the context of Ethereum but the big blockchain crypto thing that has all the attention is Bitcoin. Why is this an Ethereum thing and could this be or is this also a Bitcoin thing?

Kate Sills: So Bitcoin does have smart contracts, they’re just very, very simple. So like the tools that you can use in Bitcoin are like checking someone’s electronic signature to make sure that it’s [00:08:30] correct that they have the authority to send something. You can do what’s called a multisig wallet which is like saying that like two out of three parties have to sign in order for a transaction to happen. But if you want to do more complicated things which in most cases you do, you need to have more tools to use. And so that’s what Ethereum and some other platforms have introduced is just more conditions that you can use, like you want to do something conditioned on a timestamp, things [00:09:00] like that.

Trevor Burrus: When we talk about Ethereum there’s another thing that always kind of confused me, the term built on, when we say this is being built on Ethereum. Does this just mean that the Ethereum coding platform is sort of the backdrop of this? Is that all that’s really saying because I hear, they say these smart contacts are being built on Ethereum or even some websites and stuff are being built on Ethereum. Is it just the background coding. Is that really what we’re talking about?

Kate Sills: Yeah, so the code will be [00:09:30] run on one of these platforms and that just means that certain computers will choose to be part of the Ethereum network or the Bitcoin network or whatever it is and they’ll be running whatever code is pushed up to the blockchain. So, when people are saying this is built on the Ethereum platform or this is built on the Bitcoin platform, what they’re saying is that the code when it’s actually run is going to be run just like any of the regular transactions and it’s going to be confirmed by all of the computers in the network.

Trevor Burrus: And [00:10:00] if you’re one of the computers that’s confirming a smart contract, would you get ether from doing that, by doing the computation out of the blockchain, would you get some ether for that?

Kate Sills: Potentially.

Trevor Burrus: Or why would you do it otherwise?

Kate Sills: One way is that people have interest in just securing the network and checking that it’s correct.

Trevor Burrus: Like Wikipedia I guess.

Kate Sills: Yeah, yeah. [00:10:30] If you are the one doing the mining then you do get a reward for that. If you’re the one adding transactions to the blockchain and being kind of like the first one to validate it that way, you do get a reward for that for sure.

Aaron Powell: The first time I remember hearing about smart contracts was in a rather negative light, which was the DAO issue. So, can you first tell us what that was, what happened there and then [00:11:00] is that like the problem for smart contract technology going forward?

Kate Sills: Yeah, yeah. So with the DAO what happened was that it was intended to be a way for people to come together and invest in different things. So you would put your money in and then there was some kind of voting mechanism that would allow you to choose what it was that the money would go into. That is actually a really great use of smart contracts because once you put the money [00:11:30] in no one’s able to touch it. If you were to do this without smart contracts you would have to have an extreme amount of trust in whoever is holding the money or they’d have to be closely audited. That would be a problem, right?

Aaron Powell: So was like kind of crowd sourced venture capital?

Kate Sills: Yeah, yeah, I think that’s a good description. But what happened was there was a bug in the code that allowed someone to take out a whole bunch of the money. So, one of the limitations of smart contracts is that it’s only as [00:12:00] secure as the code that you write and outside of that there are pretty much no guarantees that there’s any kind of safety. So you can’t go to a court and say, hey, my smart contract was hacked, please help me out right.

So they were hacked and a significant amount of money was taken. I think it was something like maybe like 15% of the total Ethereum, ether at the time. What the Ethereum community decided to do was to do a hard fork basically to break [00:12:30] off from that ledger into a new history in which that hadn’t happened. So, that was the way that they were able to kind of reclaim that money from the hacker, which is great that they were able to do that but unfortunately it does undermine the whole system of the immutable smart contract where in a contract if someone is able to be powerful enough to breach the contract and then get away with it, that’s that undermines your whole concept of contract.

[00:13:00] It does kind of undermine Ethereum’s goal but I think that was very early in their history and they’ve kind of learned from that. More recently, there have been attacks that have happened and they haven’t done a fork based on that.

Trevor Burrus: So that’s an example of I don’t know if it’s a failure so much of smart contracts because it’s an evolving system and you’re looking for holes in evolutionary sense. What about successes?

Kate Sills: Yeah. So, I [00:13:30] think there’s some really exciting things being built. So, one of those things is prediction markets. So in a prediction market it’s like you’re buying a stock but you’re betting on the outcome of an event so it could be whether who gets elected president, things like that. The great thing is that it allows everyone to kind of crowd source their information the price of that stock is basically an estimation of what’s going [00:14:00] to happen. So, people, they’re putting skin in the game so it’s not just someone going on T.V. able to state whatever opinions. These are people who are actually putting their money into it.

So, the really cool thing is that it’s a way for people to create markets out of pretty much any kind of information and then an outsider can go and look at that and see what people who have insider knowledge on these things are going to be using that basically. [00:14:30] So, it’s probably the best predictions that you’re going to get. And there have been studies that have shown that.

So that’s one thing that people are building right now. Most things are still in progress and still being tested in all of that. So in terms of like clear success cases, I’m not sure if we have those yet. I think it’s very clear that there’s a lot of potential there.

Aaron Powell: So on the prediction markets, why would those benefit from smart contracts and distributed ledger because we have prediction markets right [00:15:00] now. We have Betfair and there’s that election betting odds site that aggregates them and people are doing this through centralized systems so what’s the advantage of doing it from a smart contract?

Kate Sills: It depends on how much you can trust that centralized system. So, in some cases that might be a good idea and in some cases that might be a bad idea. And then also one benefit is being able to create any of your own markets. If there isn’t a market for whatever it is that they want to bet on they can just create that. And then a third thing is eventually [00:15:30] I think you might be able to package up some of these bets and take them, you could take them to a new system. You can actually take some of these virtualized commodities and be able to buy and trade those.

Aaron Powell: So it’s one thing to say we’re going to write a smart contract that 10 dollars of mine are going to get held and then on February 1st are going to get transferred to Trevor’s wallet because February 1st is [00:16:00] an obvious date. But for more nebulous things, how do we, what triggers the smart contract and how do we, like it can’t be, there’s a lot of conditionals that can’t be themselves included in the code because it’s like was the average temperature x higher this year, whatever. How do you trigger the terms and who gets to decide?

Kate Sills: So that is a major limitation of smart contracts is because they run on the blockchain and anything [00:16:30] that runs on the blockchain has to be deterministic. If you have the same inputs, you have to get the same output. They can’t pull down code from external sources. So they can’t go to a website, let’s say a weather website and pull in the temperature. But what you can do is you can have people who push that to the blockchain. You can’t pull it but you can push it to the botching. The problem there is that …

Trevor Burrus: Can you clarify that metaphor please.

Kate Sills: Yeah, yeah. So, the [00:17:00] blockchain itself can’t go outside of it but you can always write data to the blockchain. Let’s say you want to get data about the weather, you can’t go outside and access weath​er​.com or whatever it is but you could have a trusted source go to weath​er​.com, look it up and write it to the blockchain. The problem there is that you’re relying on these trusted sources and they’re called oracles. There are different ways that people are getting around [00:17:30] that there are. These oracles might have certain reputations and you might be combining like five of them or something like that so that even if someone manages to hack a certain website you’re not ruining the consistency of the whole prediction market system.

So that is definitely a limitation of smart contracts but I think people are working around that.

Trevor Burrus: The interesting thing about, from a legal standpoint is that in contract law we do talk about [00:18:00] the way that, you know, it’s mutual obligations as a basic is what a contract is and certain obligations trigger counter‐​performance. And so, let’s take a rental contract. And one of the things I had read about preparing for this episode is kind of let’s say you’re paying rent on February 1st and not that far in the future, you could do it now, let’s say the house is opened up with a digital key as opposed to a physical key. [00:18:30] And so, upon you paying rent and it gets written and it gets confirmed and then the digital key opens up the house and that’s how you continue to live in your house.

But there are multiple conditions that go into like renting a house. So, the maintenance of the appliances for example, people kind of [inaudible 00:18:47] times, like, oh, my fridge doesn’t work therefore I’m not going to pay rent next month and I’m like, well, the nonexistence of the fridge obligation does not totally relieve you of your [00:19:00] obligation to pay rent, In actuality what we would do is we would negotiate maybe $200 off your rent but that requires lawyers and things like that.

That all seems really complex and while you could just say open the door I paid rent, that’s a smart contract. But most disputes and rental disputes for example are not that, they’re how much performance did they give and how much performance do I have to give and that’s not, that’s not code. It doesn’t seem codeable to me [00:19:30] or maybe it is, I don’t know.

Kate Sills: I think that’s a really good point. The way that I see smart contracts is that they are only useful in certain cases. They probably wouldn’t replace all legal contracts because you do have that like what is it exposed negotiation phase where you would want to, maybe the real world isn’t exactly how you expected and you need to renegotiate. I think smart contracts are really useful for when you want a very [00:20:00] severely binding commitment and like for instance maybe you want to be able to make a deal with someone that you don’t think would have your best interest in heart in that kind of negotiation and you don’t want them to be able to back out of it.

It goes back to kind of like what contract was for in the first place. I’d had mentioned Thomas Hobbes in Leviathan way back in 1651 or whatever. When [00:20:30] the words aren’t enough to bind men, Thomas Hobbes argued you need some kind of course of power over them both. Smart contracts are used for that circumstance where you don’t think that this person will be able to work things out for you or you don’t think the courts will actually be able to rule in your favor.

So, maybe you’re not in the U.S., maybe you’re in some other country where this person that you’re dealing with is a powerful figure who might [00:21:00] be able to bribe officials or the courts won’t necessarily rule in your favor.

Trevor Burrus: Or just have more money for lawyers.

Kate Sills: Right. Yeah, yeah, that’s a really good point. So Nobel Prize winning economist Oliver Williamson has this term legal centralism for the belief that courts are the best way to enforce contracts and they’re cheap and easy and none of those things are actually true. It’s not that smart contracts are cheap and easy either but I think there may be certain [00:21:30] circumstances in which they’re more valuable than taking it to a court. It might depend on what country you’re in.

There’s also the possibility for a private arbitration on the blockchain so you can write and read things to the blockchain. And some of those could be the judgments of private arbitration. You can encode things that you want to keep absolutely immutable and make sure that they are enforced. And then you can [00:22:00] also outside of maybe like the 95% of cases that you think you can encode. You could send that out for private arbitration, like take that judgment as an input to this function.

And so, there’s actually a lot of historical precedent for this. So, back in medieval times, the merchant class when they were going through all of the different countries and they would have disputes with people from different countries, there was no clear legal jurisdiction for them oftentimes. Even if they were able to [00:22:30] take it to court, the judge wouldn’t necessarily know anything about what they were doing because they had all these specialized agreements and things.

So they kind of created their own judges and their own private arbitration where they could just settle things right then and there. And so, I think this law of merchant can be used as an example for what could be possible with private arbitration and blockchain. Private arbitration is used all the time in commercial.

Aaron Powell: Just have a technical [00:23:00] question about these then. When you were first telling us how they worked you mentioned so if we’re doing a payment thing that trigger on a certain date, that if I were going to pay Trevor on a certain date, this contract would basically take a set of funds and lock them up within the contract and then release them to Trevor. But there’s a lot of instances where payment on a future date or payment on some condition, we don’t want that to take the funds away from me right now. [00:23:30] So like a loan or something where we need to use the funds or I expect to have enough like rent. You wouldn’t want me to constantly, my rent to be, all the rent I’m going to pay going on the future is taken out of my paycheck now.

Is it possible to do that too or do you always have to take the funds and lock them up in this thing before you can even get started?

Kate Sills: For the most part, that is a major limitation. You do actually have to take the funds and lock them up because there is [00:24:00] no way for and this is kind of a personal protection is that there’s no way for the box chain to take money out of your account. There’s no like taking money out of your paycheck or whatever it is that we would use in the real world to enforce someone to pay their debts.

So that money actually has to be put away and there’s an opportunity cost for that, you can’t use that money for anything else. So that is a major limitation of smart contracts [00:24:30] right now but I think there are instances in which you might want to put up a bond or put money into a contract and have it be secure and that would outweigh whatever opportunity cost there might be.

Aaron Powell: I wanted to ask about, we talked about smart contracts within the context of Bitcoin where they’re extremely limited and within the context of Ethereum where they weren’t more versatile but are there other technologies out there now or emerging that are even better and might [00:25:00] enable us to get around some of these limitations?

Kate Sills: A lot is being done on Ethereum. There are other platforms like Tezos or Cardano or DFINIITY, things like that. Even with the limitations I think there’s still a lot that you can do. So we had mentioned prediction markets. A lot of things where it’s like you can encode all of the potential possibilities. So like financial derivatives. Like actually Hernando de Soto, the Peruvian economist who wrote the Mystery of Capital [00:25:30] he’s working right now on a blockchain solution for a property title. And the smart contract in that case would be the exchange, the buying and selling of property title. So I think there are cases in which you can kind of try to encode all of that or at least like 95% of it, you want that to be enforced.

So, going back to what you said Trevor about that kind of negotiation after [00:26:00] the fact, there are lot of cases like Alaska Packers or whatever that is where you’ve made the contract but then once you actually go into performing on that contract, someone might realize that you’ve made that commitment already and try to take advantage of that. So if that’s something that you’re really worried about, a smart contract might be the way to ensure that there is no way that you can renegotiate that once you’ve already committed.

Aaron Powell: You mentioned Tezos which I know from your Twitter [00:26:30] feed is something that you talk a lot about. So what is Tezos and how does it fit into all of this?

Kate Sills: Sure. So Tezos is kind of an Ethereum competitor. They started around the same time. Tezos put out a white paper in 2014. Their focus is trying to make business contracts. So, the co‐​founders Kathleen and Arthur Breitman are kind of from the finance area. So, they’re hoping instead of Ethereum [00:27:00] which is kind of like smart contracts can do anything. Ethereum has this, right now one of their major apps is this thing called cryptokitties, which is like virtual trading cards basically that have like a little cat on them and you can buy and sell those and like breed them together and get a new cat.

They’ve like very much embraced, like, you know, you can do anything with this but I think Tezos is interested in using it first more of these like business use [00:27:30] cases where you might just want a very simple contract just to make sure that whatever it is that you’re trying to promise each other is actually enforced.

Trevor Burrus: When it comes to the writing the terms the blockchain, how much of a problem is it getting them, it’s hard to take things off the blockchain if not impossible where you make a contract, in PayPal, like let’s say I did [00:28:00] a contract with someone, an eBay and it was upon shipment of this thing and then the funds are released and given to them and written to the blockchain and then when I get it, it’s either defective or maybe it’s a counterfeit or something like that, how can you go back and be like, no, no, no, no, I want my money back because it’s written into the chain now?

Kate Sills: That’s something that people are working on but part of the security of the whole system is that [00:28:30] you can’t go back and rewrite things. So people definitely don’t want to undermine that. But what you could do is you could have a what we are talking about a multisig wallet where if everything goes well, the seller approves it, you the buyer, you approve the transaction, you’ve gotten your good and the transaction happens. But if something doesn’t go right then there might be some kind of third party that would be able to kind of adjudicate that and decide [00:29:00] where the money should go.

So, there are ways to get around that but the security of the system is based on ensuring that you can’t actually change anything that’s happened previously in the ledger.

Trevor Burrus: But does that mean that maybe people, for something like that, the blockchain is not the optimal. Maybe people if you told them okay, well, this is really hard to take back and we have a way around it but it might take all these different things but actually one of [00:29:30] the services that PayPal offers is you can say stop, stop this right now and people say okay. So maybe for eBay transaction the blockchain just won’t actually be something people want to use, it’s smart contracts and the blockchain.

Kate Sills: I think it really all depends on what your use case is. If you’re use case is like ease of use then the blockchain probably isn’t for you. It’s kind of like, you know, if you don’t care about who’s looking at your email [00:30:00] right you could just use Gmail or whatever it is and that’s probably the best option. If you have a specialized case where you don’t necessarily want to trust someone like PayPal, you are able to make those exchanges with other people and right now it is a little bit more complicated but I think we’ll see a lot more of the kind of like user friendly apps. There are decentralized marketplaces right now that have been [00:30:30] working on that sort of thing and so I think once that becomes more popular, it’ll probably become more easier to use.

Aaron Powell: A lot of libertarians like this tech, blockchain and cryptocurrencies and smart contract because it fits into grand utopian crypto anarchist visions of, you have a presentation you did on smart contract in order and anarchy, this is how we can [00:31:00] make it so we don’t need the state. There’s things that we thought we needed the state for but we can replace them with technology. And I admit that’s a really, I mean for me a really exciting vision but one concern or question I have about it is we talk about these things as if this is just kind of technology exists out there, we can use it. But this is technology being created by people. It’s overseen by people or organizations. Because [00:31:30] it’s tech it needs to be updated, it needs to have bugs fixed.

As with any you know large software open source project there’s like a governance issue at play and one thing that’s become apparent especially over maybe the last year is that a lot of the times in the space the government seems pretty broken or dysfunctional. The people who are in it are [00:32:00] either too ideologically hardcore to function, to actually make the technology change in ways it needs to or are simply dysfunctional.

And so, is there a problem there with shifting from essentially entrusting this highly troublesome government that we have that has all sorts of problems and has incompetent people in it, it has bad people in addition to competent good people [00:32:30] but is at least we have mechanisms in place where we can correct, it’s like answerable in a sometimes superficial way but it’s answerable to us. From shifting from that to relying on technology and ultimately code as law that’s being overseen by some random hacker somewhere, often anonymous people, organizations that don’t even really exist on paper, there [00:33:00] isn’t a thing there and there aren’t institutions in place.

Kate Sills: Well, I think anytime you have any sort of collective action, you have a governance problem. Even if you’re deciding where to go to lunch with your coworkers that’s still a governance problem. How do you decide that, how do you decide that fairly? What if there is one minority voice that really loves a certain restaurant and you never ever go there. So, any time you have some kind of collective action problem where you’re trying to make a group decision, [00:33:30] I think you’re going to have a governance problem.

And then the question is how do fairly resolve it. In a lot of the cryptocurrency platforms right now like Bitcoin and Ethereum, it’s kind of ad hoc thing. And so that means that there’s a lot of vicious Twitter fights basically especially in the Bitcoin community. Some people are trying to formalize that, so Tezos for example is really trying to formalize that and put the governance itself on the blockchain. As libertarians I think we [00:34:00] often get told by other people like government is just us working together and then our reaction is well, usually people working together don’t force you to do things or like we didn’t consent to this.

I think the special thing about blockchain is that because you can exit, right, so unlike a geographic territory where like the government there is, it’s harder to exit. You have to actually move and [00:34:30] go away from all of your friends and family and move all of your stuff. On the blockchain you could just sell out and move to something else or you could do a fork which is kind of like a political revolution in a way and try to convince people to go your direction.

Even though there’s not necessarily the accountability, there’s not a way in which you can voice your opinions very easy except on Twitter or something like that, [00:35:00] you do always have the exit option in a way that’s easier than the kind of governance that we’re used to seeing in the real world. I think we will see in the next couple of years people really trying out different governance systems. Different ways of trying to make collective action decisions and make group decisions and I think that’s something that’s going to be really cool to see especially with smart contracts because you can use smart contracts [00:35:30] to bind yourself to whatever decisions it is.

So, you might put up a bond or something like that that might be slashed if you don’t adhere to whatever rules you agreed to. But I think that it’s still an open area of study definitely in its infancy and I’m excited to see where it goes.

Trevor Burrus: For a very long time we studied government and James Madison before the Constitution sits down and reads all these books about government and how doe we make it better, it’s always [00:36:00] a work in progress so with this new technology I guess we’re trying to figure some of these things out too.

There was an article in December that got some amount of attention at least in my news feed by a guy named Kai Stinchcombe called Ten years in, nobody has come up with a use for blockchain, criticizing many of the purported applications.

And on smart contracts he writes, “The investors and startups in the smart contract space promise that the blockchain will enable super fast execution and payment. For example [00:36:30] that in healthcare applications instead of waiting 90 to 180 days for a claim to be processed or spending hours on the phone trying to get your bill paid it can in theory be process on the spot. But that’s true of any software enabled purchasing system. My company’s Amazon server scale automatically based on the website traffic and bill us for how much we use. The idea the smart contacts would change this is a fallacy. It conflates a legal arrangement being put into effect with the software in the legal range itself being coded as software. Amazon’s terms of service are not a smart contract [00:37:00] but the billing system that implements those terms is automated. To the extent that health insurance billing for example is not automated, the problem isn’t that existing software isn’t smart enough to handle submitting claims and paying them electronically, it’s that the insurance company is slow moving either by accident or because on purpose they prefer a human review.”

How do you respond to that critique?

Kate Sills: Yeah, well, I don’t disagree with it. I think blockchains are very slow. [00:37:30] Their advantage is not that they’re faster. I think a lot of that comes from this idea that smart contracts have something to do with AI that they’re smarter. Actually in a lot of ways they’re dumber. They can only do certain things in certain ways.

So, I don’t disagree with that necessarily but I do think the use case for blockchain and smart contracts in particular has to do with the collective action problems that I was talking about and the social consensus. So, [00:38:00] money is a social consensus. Property title is also a social consensus. It’s the agreement of everyone else to not violate the rights that have been defined that you have ownership of. And so, all of those things when you look at the system, the machine that that runs on right now it is incredibly slow, right, that’s government.

I have a friend who’s been trying to get the title for his car for like almost a year now and he’s been driving the car around [00:38:30] but he can’t get the title for it so he can’t sell it and all of those things. So Hernando de Soto in the Mystery of Capital, his thesis was that people in third world countries it’s not that they are poor because they don’t have possessions, it’s that they don’t have the title to all of these things. They’re missing the institutions so they’re missing the rule of law that would allow them to use their property as collateral or to leverage [00:39:00] it in all of these different ways. It’s the mental representation of their property that they’re missing. The strength of blockchain is that you’re able to create that kind of social consensus and put it in a ledger and make it immutable and allow you to buy and sell and trade that.

So I think the use case for smart contracts isn’t necessarily that you would be paying an insurance company or trying [00:39:30] to bypass an insurance company or anything like that …

Trevor Burrus: Using that as like your new payment system.

Kate Sills: Right. I think digital currencies themselves are really, really important because it makes it much easier to cross borders and interact with people throughout the whole world much easier. For smart contracts I think there’s a couple of things that the situation has to have to make smart contracts useful. And one of those is opportunism. So, if you have a use case in which you think [00:40:00] someone is going to take advantage of you, Oliver Williamson defines this as self‐​interest with guile. And a lot of contracts that happen, so like we can imagine back in Hobbes time like in the 1600’s, let’s say I have a pig that I want to sell at the market and a farmer wants to buy it and he agrees to give me his harvest next fall and we make that agreement and I give him the pig and the next fall rolls around and he might say, hey, I didn’t have any kind of deal.

[00:40:30] So that kind of opportunism, right, when the opportunity arises using it for your own self interest, I think that usually indicates that you need some kind of outside enforcement. So either that’s a legal contract or a smart contract. But you need some way to enforce it. So I think when you have cases of opportunism that involve some kind of social consensus that’s needed. So like things to do with property title or …

Trevor Burrus: [00:41:00] Long term contracts and things like that where someone can run away.

Kate Sills: Right, right, right. Maybe your situation, you live in a country that doesn’t have secure institutions and you don’t trust them, I think that’s where the blockchain really shines is that, the blockchain is not trying to replace our programming and our Amazon servers and all that. It’s trying to replace how we interact with [00:41:30] each other and how we try to get each other to cooperate. So it’s trying to replace that collective action layer which has for the most part been a service provided by government. I think if you look in most cases that is incredibly slow if it functions at all.

Trevor Burrus: Are you familiar with the verification system for indentures? Hanging on my office wall is an indenture, a contract written for someone to be indentured servitude for [00:42:00] seven years coming over the standard story. The term indenture actually means the scroll at the top of the contract. So when you are indentured and then someone held the indenture for you, it was a big piece of paper and you each had a copy and then you cut it in a scroll. And the way you verified it was to match them up against each other and seven years later you come back and like, or 20 years [00:42:30] where you might look really different and you have to prove the same person so you put the two scrolls up against each other and again it says I’m the original holder of this, this is the indenture.

It kind of is one of these technologies they try to invent to verify a transaction and keep it over a long period of time as opposed to just a handshake deal, like right now you want these chickens, yeah, here’s some money I’ll buy them later. But if you have a 20 year thing you might need something a little bit more for that.

Kate Sills: There are a whole bunch [00:43:00] of ways that people have tried to come up with to make it more probable that someone’s going to keep their promise. Like Oliver Williamson and other people in kind of the law and economics subfield call this private ordering. So you might rely on like personal ethics, you might only make deals with someone that you think is a good person but that kind of information is hard to come by.

Trevor Burrus: It makes you probably pretty poor.

Kate Sills: Yeah. It really [00:43:30] limits all of your transactions. You might rely on like reputations. You might ask other people what their previous transactions with this person have been. And so, in game theory that’s taking like a single instance game and turning it into a repeated game because people have an incentive to cooperate in order to ensure that they have an opportunity to take that next deal.

So I think what smart contracts provide is not necessarily this [00:44:00] is the way that you must do things, you must make this binding contract, it’s a way to allow people in code to use whatever level of mechanism that they need to use in order to try to ensure that someone will keep their promise. And a lot of these systems, they’re using things like reputation in order to try to ensure that. That gives you a little bit more leeway in negotiations while still trying to secure that promise. The idea of it is that there is no one [00:44:30] particular way that is above and beyond the way that you should do things, different use cases need different types of tools and this is a new tool that we have.

Aaron Powell: You mentioned immutability and trust a fair amount and that this is a way for people who might not otherwise have access to the rule of law effectively to use a trusted system that can’t be changed. But at the beginning of our conversation we talked about the DAO and hard forks which was [00:45:00] basically up and changing and it’s not just … If you and I make a contract and then a corrupt state court decides not to enforce it or rewrites the terms or something like that, our contract has been screwed up but a contract that I have with Trevor still is around. But if these are all written to the same blockchain and then the [00:45:30] guys at Ethereum decide that they want a hard fork it in order to save the 15% of Ethereum that was caught up in this thing, that also rewrote or went back on every single other contract that was in existence at the time or that had happened between when the point that they decide to hard fork and everything that happened after that.

And so, that’s like an extraordinarily huge level of mutability. Is that a concern that these [00:46:00] people in poor countries that you could just buy, say 51% miners deciding they could wipe out every single contract and every single claim to property across the whole world?

Kate Sills: So I think it’s important to view it in layers because I think in any institution, let’s say in the U.S. we have the constitution, we have the rule of law and we can we can make contracts. But if someone [00:46:30] invaded the U.S. or somehow the government got overthrown, all of those might be in question. So, I think you have to view it in layers and say like, as long as the system itself is secure, then your contract is secure. I think you’re right, that is something that is concerning. You definitely don’t want people to be able to up end the whole system. Like it takes a ton of computing power to actually be able [00:47:00] to change the system and you have to convince everyone to go along with your hard fork if that’s the case. Otherwise you might find yourself in a very minority fork where your value goes way down.

Really only in very worrying cases that this hard fork scenario might actually happen. I don’t think that the example that you gave of a contract just between you and another person would not be a case in which that would happen. So, the good thing is is that [00:47:30] unlike court that we might experience in real life where we might have fickle decision or a biased court or in a different country maybe someone might have been bribed or something like that, on a, instance per instance level it’s probably very, very unlikely that it’s actually going to be changed or that it’s going to be undermined unless it’s something that you’re making a deal that is so big that it’s like 20% or 30% of the money in the system, that [00:48:00] might be something that people will try to mess with.

But I think for the ordinary people for the little guys, you can count on the system.

Trevor Burrus: Going forward, what do you see as are like the things we should look for smart contract maybe in the near term and then in the long term as someone who’s actually working on this. Where do you think in the next 10 years will we start seeing these things maybe pop up?

Kate Sills: So, one thing that’s really interesting is that some people are [00:48:30] starting to use smart contracts for debt. So, being able to buy and sell debt and do so in a way that crosses borders. That’s one thing that’s really interesting. And connected to that is the idea that if we did have property title on the blockchain in a certain country or something like that, investors worldwide would be able to buy and sell that. Basically, it’s unleashing all of this [00:49:00] captured economic activity that has kind of been siloed into each geographic jurisdiction and allowing people to connect worldwide. You’re not only just allowed to invest in your own country stuff, you can exchange those things with anyone in the world. Those are the kinds of use cases that I’m really excited about.

I think also one use case that has been really undervalued is the ability to create commitments [00:49:30] outside of something that the court might enforce. Thomas Schelling talked about this way back in the 1950’s. He wrote a paper on bargaining. And his argument was that it was counterintuitively. If you’re able to bind yourself in certain circumstances, it actually gives you a lot more power in bargaining. Correct me if I’m wrong, I’m not a legal scholar but the courts did not enforce one party contracts with yourself for the most part. It doesn’t make sense.

Trevor Burrus: It doesn’t make any sense. It’s incoherent, yes. There’s no meeting of the minds.

Kate Sills: [00:50:00] Right, right, right. This is still an area that I’m hoping to do more research on but I think we haven’t seen what will happen when people can actually create commitments that don’t have to be evaluated by a third party, right, that you can …

One example of this that Thomas Schelling talks about is like nuclear deterrence. The whole point of having [00:50:30] someone, like if someone’s going to attack you, you have you know a switch that it will automatically attack them. Not that you would be using this in terms of nuclear weapons but you can think of like maybe you want to put up some kind of a bonds that will be slashed if you act in a certain way or maybe you’re in negotiations with someone and you want to be able to credibly commit to something and convince them that no, sorry, I can’t actually do that. [00:51:00] For instance, let’s say you’re an employer negotiating with the union or something like that and they would like to raise wages and if you’re able to say sorry, it’s literally not possible for me to do, that actually gives you a lot more bargaining power.

Trevor Burrus: As opposed to just say it, like actually commit yourself.

Kate Sills: Right. Yeah. So there’s ways that we just have not explored because we haven’t had the tools to do that and in this paper Thomas Schelling says it’s actually astounding [00:51:30] that there’s been no way to actually have these kinds of commitment devices. With that and with private arbitration on the blockchain and being able to do this outside of all of these geographic jurisdictions, I think there’s a lot of potential that still is left to be explored and I’m hoping people who are experts in law and economics get really interested and start exploring because it is kind of a sandbox for exploration.

If you admire [00:52:00] James Madison and you’re interested in like [inaudible 00:52:04] like three branches of government and you want to, you’re like, well what would happen if you didn’t have that or if you had other ways of formatting this. It’s an open question but you can actually start implementing now and people need it because a lot of the people who are working on blockchain stuff do come from like a computer science background or finance background and they don’t have necessarily the [00:52:30] legal or economic background that you would need to be able to build the governance system or try out some of these contract forms or things like that.

Trevor Burrus: Free Thoughts is produced by Tess Terrible. If you enjoyed today’s show, please rate and review us on iTunes and if you’d like to learn more about libertarianism, find us on the web at www​.lib​er​tar​i​an​ism​.org.