Promises vs Smart Contracts

My prior blog post, It’s Time for Smarter ContractsIt’s Time for Smarter Contracts
Traditional contracts are fraught with problems, it is time to rethink the structure and enforcability of all contracts whether or not we encode them in software as smart contracts.
, generated some legitimate questions about the limitations of limiting contracting to those things which can, in theory, be implemented as a smart contract. In particular, there are so many contracts that we sign today that could never be implemented as smart contracts that it is inconceivable how society could function.

What would happen if no contracts were enforceable by law? Would you still be able to buy goods and services. I think so! The vast majority of business takes place without a contract. More often than not, the purpose of a contract is to counteract the risk of courts imputing and enforcing terms and liabilities on parties after the fact. The contract becomes a means of returning to a world without enforceable promises and potentially unlimited and unknowable liability.

By adopting smarter contracts, those that can be expressed as conditional title transfers and implemented in software, we automatically eliminate the need for frivolous contracts. As a consequence we put responsibility on individuals to vet the trustworthiness of those they do business with because their mere promises are not enforceable.

To make promises enforceable (without a bond), is to imbue them with the characteristics of property. My promise to pay you $1 trillion dollars becomes an asset on your books because “by law” if I fail to pay, the government is supposed to make me pay. Everyone should know that I don’t have $1 trillion dollars and there is nothing the government can do to enforce this contract. The damages one seeks from broken promises must come from somewhere. If there are no assets to back the promise then the promise has no value.

This is obvious for anyone doing business with the poor. No matter what contract a poor person signs, if they don’t keep their promise there is nothing you can do to collect damages. You can’t get blood out of a turnip.

The consequence of enforcing promises (as opposed to conditional title transfers), is to encourage people to build their economic house on a foundation of sand. It enables fraud by transmuting something that should have no value into something that is presumed to have value. An insurance company makes promises to provide a level of coverage that they mathematically cannot keep in certain circumstances. Those relying upon that promise will be disappointed when after years of paying premiums to the insurance company which is paying dividends to shareholders the insurance company goes bankrupt when you need them most because they misestimated the magnitude and frequency of claims.

Banks make promises to pay “on demand”. Manufacturers make promises to provide a warranty. We assume these promises are worth something because people perceive the companies to be “big” and “rich” compared their customer. The problem is that in order for a company to make good on its promises it must set aside capital to “self insure” against defects. This capital must come from the customers in the form of increased prices. Since the manufacturer cannot possibly know the magnitude of potential claims and liability they will either end up overcharging or over promising and neither the customer nor the manufacturer knows the reality.

Even under the “promise theory of contracts”, a contract must have the consent of the parties to be considered valid. In order to consent one must have knowledge. How can one have knowledge of the extent to which your failure to perform a promise will “harm” the other party if you must wait for a judge to “assess” damages after the fact? If you do not know the limits on your liability then how can you consent? If you lack the ability to pay the damages as outlined in the contract, then how is a government to enforce it? The supposed contract is invalid to both sides, one side is unable to consent while the other side is unable to collect.

Imagine you signed 1000 contracts for various things and in each individual case you have the ability to pay the potential damages but only if you don’t default on any of the other 999 contracts. How is this different than fractional reserve banking? Are your counter-parties aware of the risk that you may not be able to pay?

The purpose of smarter contracts is to expose the reality of the risks we are taking. To make it explicit when we are relying upon a handshake without recourse and when we have recourse. While it may be “comforting” to pretend that all the promises others make to us are enforceable, it will ultimately undermine the very fabric of society when reality violates everyone’s unrealistic expectations of others.

© Daniel Larimer