The Siren Song: Algorithmic Governance by Blockchain

Kevin Werbach - The Wharton School, University of Pennsylvania

-- Could cryptographically-secured computer code that automatically enforces agreements replace the messiness of lawyers, courts, and contracts? That is the promise of blockchain technology. Blockchains facilitate trusted transactions that do not require trust in any particular party or intermediary. But there is a catch. In The Siren Song: Algorithmic Governance by Blockchain, a chapter in After the Digital Tornado: Networks, Algorithms, Humanity (Cambridge University Press, September 2020), I explain that, to succeed at scale, blockchain-based networks and services must address the hard problems of governance.

Contracts are powerful means of generating trust because they backstop voluntary human commitments with formalized legal enforcement. Blockchain-based “smart contracts” are designed to offer a similar kind of confidence through transactional immutability, backed by the cryptographic integrity of the blockchain ledger. In the ancient Greek classic, The Odyssey, the hero orders his men to lash him to the mast of his ship, so that he cannot respond to the beautiful songs of the Sirens. He radically disempowers himself ahead of time, because he knows he will not be trustworthy under the Sirens’ enchantment. A similar strategy lies at the heart of blockchain’s capability to decentralize trust. Smart contract agreements can be trusted, in theory, because no one retains the power to break or alter them.

Immutability poses a novel set of legal and regulatory challenges. What happens if a transaction is plainly illegal or harmful, but no one has the capability to prevent it? Or a transaction is technically valid, but needs to be changed due to mistakes or changed circumstances? Immutability creates the potential for catastrophic failures with no clear means of remediation.

Three examples illustrate the problems with blockchain immutability. In the DAO hack, an attacker used a bug in the smart contracts of a decentralized crowdfunding application, potentially stealing $60 million of cryptocurrency. The only way to return the money to its rightful owners was to execute a hard fork that broke the immutability of the entire underlying Ethereum blockchain. The Parity wallet bug resulted in $150 million of cryptocurrency becoming permanently inaccessible when one user deleted a smart contract required to access it, allegedly to prevent exploitation of a security vulnerability. The abortive Segwit2x fork was an agreement to increase the capacity of the Bitcoin network, which partially failed when the human consensus around it collapsed. In each case, there was no workable governance process created ahead of time to coordinate actions of the relevant communities.

Such problems are inevitable in blockchain systems. Smart contracts necessarily lack capacity to distinguish the scenarios for which immutability was designed from those where it causes harm. Contracts of any consequence are generally incomplete; that is to say, they do not precisely specify outcomes for every possible scenario. Smart contracts magnify this incompleteness. They can only express their terms in sharp-edged software code, eliminating the interpretive discretion of human judges and juries.

The best way forward is to incorporate governance systematically into the development and oversight of blockchain-based systems. Given the structure of blockchains, governance cannot be an afterthought. Nor can it be limited to formalized voting on changes to network algorithms, as voting structures insufficiently address the diversity of governance challenges that can arise. Instead, drawing on the literature of polycentric governance and commons management, governance mechanisms must be established at multiple layers of blockchain ecosystems, and adapted to the unique needs of each transactional community.

Lawyers should study the ways that blockchain networks try—or don’t—to resolve the inherent tensions of immutability. The reliability and programmability of smart contracts will be appealing for traditional legal arrangements as well as exotic blockchain applications.

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