Tag Archives: arbitration

Stop Saying Bitcoin Transactions Aren’t Reversible

One of the criticisms leveled at Bitcoin by those people determined to hate it is that Bitcoin transactions are irreversible. If I buy goods from an anonymous counterparty online, what’s to stop them from taking my bitcoins and simply not sending me the goods? When I buy goods online using Visa or American Express, if the goods never arrive, or if they aren’t what was advertised, I can complain to the credit card company. The company will do a cursory investigation, and if they find that I was indeed likely ripped off, they will refund me my money. Credit card transactions are reversible, Bitcoin transactions are not. For this service (among others), credit card companies charge merchants a few percentage points on the transaction.

The problem with this account is that it’s not true: Baked into the Bitcoin protocol, there is support for what are known as “m-of-n” or “multisignature” transactions, transactions that require some number m out of some higher number n parties to sign off.

The simplest variant is a 2-of-3 transaction. Let’s say that I want to buy goods online from an anonymous counterparty. I transfer money to an address jointly controlled by me, the counterparty, and a third-party arbitrator (maybe even Amex). If I get the goods, they are acceptable, and I am honest, I sign the money away to the seller. The seller also signs, and since 2 out of 3 of us have signed, he receives his money. If there is a problem with the goods or if I am dishonest, I sign the bitcoins back to myself and appeal to the arbitrator. The arbitrator, like a credit card company, will do an investigation, make a ruling, and either agree to transfer the funds back to me or to the merchant; again, 2 of 3 parties must agree to transfer the funds.

This is not an escrow service; at no point can the arbitrator abscond with the funds. The arbitrator is paid a market rate in advance for his services, which are offered according to terms agreed upon by all three parties. This is better than the equivalent service using credit cards, because credit cards rely on huge network effects and consequently there are only a handful of suppliers of such transaction arbitration. Using Bitcoin, anyone can be an abitrator, including the traditional credit card companies (although they might have to lower their fees). Competition in both terms and fees is likely to result in better discovery of efficient rules for dispute resolution.

While multisignature transactions are not well understood, they are right there in the Bitcoin protocol, as much a valid Bitcoin transaction as any other. So some Bitcoin transactions are irreversible; others are reversible, exactly as reversible as credit card transactions are.

Bitrated.com is a new site (announced yesterday on Hacker News) that facilitates setting up multisignature transactions. Bitcoin client support for multisignature transactions is limited, so the site helps create addresses that conform to the m-of-n specifications. At no point does the site have access to the funds in the multisignature address.

In addition, Bitrated provides a marketplace where people can advertise their arbitration services. Users are able to set up transactions using arbitrators both from the site or from anywhere else. The entire project is open source, so if you want to set up a competing directory, go for it.

What excites me most about the decentralized arbitration afforded by multisignature transactions is that it could be the beginnings of a Common Law for the Internet. The plain, ordinary Common Law developed as the result of competing courts that issued opinions basically as advertisements of how fair and impartial they were. We could see something similar with Bitcoin arbitration. If arbitrators sign their transactions with links to and a cryptographic hash of a PDF that explains why they ruled as they did, we could see real competition in the articulation of rules. Over time, some of these articulations could come to be widely accepted and form a body of Bitcoin precedent. I look forward to reading the subsequent Restatements.

Multisignature transactions are just one of the many innovations buried deep in the Bitcoin protocol that have yet to be widely utilized. As the community matures and makes full use of the protocol, it will become more clear that Bitcoin is not just a currency but a platform for financial innovation.

What Would Stateless Internet Courts Be Like?

Last year I wrote that there are benefits to operating a business that is subject to state law. As Schelling says, the right to be sued is the power to make a promise. Increasingly, however, there seems to be interest in running profit-making internet ventures that are immune to state control. There may be a market, therefore, for a private court that accommodates such activity. In this post, I’ll present an outline of what such a court might be like.

There are a number of private arbitration firms in the world, but in general they are not suited to deal with stateless actors, particularly those who wish to avoid state control altogether. First, they themselves rely on state law to a large extent. Firms who go to arbitration often do so because their contracts prescribe arbitration; these contracts are the ordinary state-enforceable sort. Because state law casts its shadow on private arbitration (and the disputing firms prefer it), judgments are typically secret. The secrecy of judgments creates problems. Secret judgments increase the incentive for lazy arbitrators to split the difference, rather than search for actual fault. Recently, in order to combat difference-splitting, arbitrators have relied increasingly on American-style procedural rules, which has increased the cost of arbitration and eroded one of the major benefits of private adjudication, its lower cost.

Second, private arbitration firms to my knowledge are not typically prepared to accept disputes between pseudonymous parties. Firms on the internet who seek to avoid state control must use pseudonyms; otherwise states would be able to track them down and interfere with their businesses. It’s imperative that the arbitration firm or court not have access to any concealed real identities of the parties. Otherwise if the identity of the arbitrator is discovered, the government could extract the real identities and prosecute accordingly.

Since a private internet court must attract business without the machinery of the state, most of its rulings would need to be public. It would want to develop a reputation as a truth- and fairness-seeking body. Its opinions would need to be clear, well-reasoned, and principled. Past rulings would serve effectively as advertisements to bring in future business. It could occasionally offer secret proceedings if both parties publicly agreed to be bound by them, but in equilibrium, these would cost more since they could not be used as advertisements.

Since the court could not rely on the state to enforce its rulings, it would need to maintain a publicly accessible database of the compliance of defendants with its rulings. Market participants should be able to query the database with the pseudonym, trade name, or public encryption key of any online business and be able to see immediately whether that entity is out of compliance with the court’s ruling, and if the proceedings were public, the evidence and explanation of the ruling.

To bring a case, a plaintiff would have to pay the court’s fee up front. If the plaintiff won his case, the defendant could be ordered to reimburse the plaintiff for this fee. This ensures that the court always gets paid, and it is the only system I can think of that is fully compatible with the purely voluntary nature of the trial.

What if the defendant declines to participate in the trial? The court cannot force him to participate, but this is less of a problem than it at first seems. The court still has an incentive to supply a fair ruling (which, again, will be publicly verifiable). If it does not, then its database of out-of-compliance defendants becomes worthless. No one will pay attention to a database of people that plaintiffs sued in a corrupt court. For the database to have value, it must at least correlate with fair rulings.

Once one private internet court gets started, it will likely face competition. Courts will compete on fees and reputation for fairness. This will generate a search for efficient rules of civil procedure: what rules of procedure make the optimal tradeoff between cost and information? My intuition is that for the kinds of cases we’re discussing, the rules will need to be very low cost. Since the enforcement mechanism relies entirely on reputation, and firms can always “declare bankruptcy” on their reputation and start over, the cases that will be brought will be relatively small, at least at first. Therefore, the cost of litigation must be low enough to make adjudication worthwhile. I would expect there to be no discovery, which is very costly. In equilibrium, private courts would probably receive a complaint from a plaintiff and a response from the defendant, and then have the opportunity to question both parties. It would then issue a judgment.

While the scenario I have sketched above may seem far-fetched, there are lots of parallels between it and the actual development of merchant law and Anglo-American common law. Early courts in these traditions had little power to enforce their rulings. They also faced competition from other courts, and issued public rulings in order to establish reputations for fairness and efficiency.

If Bitcoin can get past its recent struggles (1, 2, 3, 4), or if some successor medium of exchange is more successful, then demand for state-free adjudication may increase. I’m not ready to abandon my current career plans yet, but given my academic interest in private governance, the internet, and law and economics, I’m willing to hear cases on an ad hoc basis. If you think you’ve been ripped off by a merchant on Silk Road, get in touch. I’m ready to claim universal jurisdiction.