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Decentralization over blockchain infrastructures: the property-contract interface

on July 13, 2021

Photo by Thought Catalog on Unsplash.

Written by Enrico Rossi – Research Fellow (post-doc) at UCL Computer Science Department and previously Fellow at  The London School of Economics and Political Science (LSE) 

Blockchain technology has acquired increasing importance in the last decade. The technology emerged to implement peer to peer transactions of digital money that could displace commercial banks’ gatekeeping of digital transactions of bank deposits and central banks’ monopoly over the value (and therefore supply) of fiat money. Since then, blockchain has been adopted in many industries and for many purposes, such as supply chain management, privacy and identity management, internet of things (IoT), distributed computing and databases, online voting, healthcare and pharma, insurance, and many others. 

Yet, even though there is a widespread general understanding that blockchain “decentralizes” transactions among pseudonymous and geographically dispersed peers connected to the infrastructure, there is a fundamental question that is usually overlooked and still remains open and unanswered: how we should consider decentralization over blockchain infrastructures? does blockchain decentralizes the institution of property (property rights), or it decentralizes the institution of contract (contract rights)?   

The question may sound trivial but it has some important implications that should not be overlooked. If one looks at the historical evolution of blockchain, one would note that this ambiguity is inherent in, and emerges from, the history of the technology. Blockchain technology has evolved throughout the years, moving from its original nature as a dedicated infrastructure only supporting native coins inherently linked to the associated protocol (such as bitcoin and all other early native coins that emerged soon after, such as Litecoin, Dash and Monero) to a general purpose (Touring complete) platform supporting a variety of tokens issued over it, fuelled by the automatic and decentralised execution and enforcement of smart contracts (such as in the case of Ethereum, and all other platforms that support a DeFi ecosystem, such as Cardano, EOS, NEO, Polkadot, and others). While the former was mainly interested in ensuring the transparency and eventual consistency of the system that becomes necessary whenever property rights over rivalrous (scarce) and appropriable (excludable) things are involved, the latter is mainly interested in the problems posed by incomplete contracts in case of uncertainty and opportunism, such as hold up or moral hazard, consistent with the long-standing teachings of transaction-cost economics and principal-agent theory. In a sense, it is possible to say that the former is mainly interested in retaining the static coherence of the system among all of its actors, while the latter is mainly interested in ensuring ex-ante and ex-post consistency over time.   

Although the transaction of any property right between two parties obviously involves some form of contract, contract rights and property rights are not the same thing, and present some fundamental differences from a legal and economic perspective: while contract rights are in personam special rights, property rights are in rem general rights. The former implies that contracts bind and constraint only a predefined and circumscribed set of actors (rights in personam) given specific and contingent circumstances (special). The latter imposes duties and obligations on all actors subject to the same institutional regime (duty holders should not be identified ex-ante: rights in rem), and are usually characterised by standard and not contingent forms and duties (general rights).  

Why is this distinction relevant when it comes to blockchain technologies? It is possible to provide two separate, yet somewhat related, answers to this question and both revolve around the core essence of the blockchain (even though from two different points of view): its decentralised nature.  

For one, economic theory teaches us that property rights and contract rights conflate only in case of perfectly working markets or, in other words, whenever transaction costs are equal to zero. 

This is the ideal case of perfectly decentralised and self-governing institution-less societies. Even though blockchain is usually portrayed as the archetype of a decentralised, and therefore frictionless, technology, there are many sources of market failures, and therefore centralization, plaguing blockchain technology. Among those, the most relevant ones are the on-chain concentration of power generating the potential for a variety of attacks (such as majority attack, sybil attacks, bribery attack, or discrimination through blacklisting), the presence of centralised hubs acting as intermediaries (such as trading platforms, oracles, issuers or custodians), or the off-chain power of the core developers, funders, or lead maintainers of a platform. 

In other words, when the overall picture is considered (on-chain power, power of interfaces, and off-chain power), it can be safe to conclude that in rem property rights should be understood differently from in personam contract right.

This leads to the second, and most relevant, point:    

The meaning of Decentralisation

In fact, what is usually overlooked by the blockchain community is that the meaning of (de)-centralization changes based on whether property rights or contract rights are involved. When a contractual transaction is considered, centralization implies some form of inequality or asymmetry (typically in power dynamics). There are many ways in which this unbalance in power can manifest itself and emerge, but regardless from the fact that it is in the form of hold-up, opportunism, moral hazard, adverse selection, and regardless from the fact that it may emerge due to asymmetries in information, knowledge, capabilities, status, wealth, or other social categories, centralization of contract rights typically derive from one party exercising some form of power over another one. Conversely, decentralization denotes the absence of these power asymmetries. 

I would argue that this is not the case for (in rem) property rights.

In this second case, centralization denotes some form of the logical and epistemic univocity of the system, ensuring the indivisibility and the non-decomposability of systems, while decentralization implies the possibility to partition and decompose (or divide) a system into concurrent and multiple subsystems, each endowed with their own (potentially inconsistent and incompatible) logic and semantic.  

As a result, it should be noted that while centralization in the case of contracts (rights in personam) is a negative and detrimental thing of a system generating suboptimal outcomes that the blockchain should address and hopefully solve, centralization in the case of property rights (rights in rem) is a positive aspect of a system, that the blockchain should preserve, ensure, and guarantee in the face of decentralised failures.

 This is consistent with current legal and economic thinking, which treats contractual rights as an inherently decentralised institution (centralization emerging only as a suboptimal remedy in case of failures), while property rights as an inherently centralised institution (decentralization denoting failures and shortcomings of the institutional system). Stated even differently, contract rights are private (and therefore inherently decentralised) claims, while property rights are public (and therefore inherently centralised) claims.   

We should then be allowed to ask: is blockchain a decentralised technology trying to address and avoid the failures of centralization, or a centralizing technology trying to address the problems and shortcomings of decentralization? In other words, any system developer or system architect should clarify whether the blockchain protocol establishes and enforces digitised public claims, or rather it executes and enforces private claims. 

My suggestion is that the answer depends on the legal category considered: blockchain as a technology of smart contracts should be understood in the former, blockchain as a technology of digital property claims falls within the latter. I would argue that the former is mainly the case of Ethereum and decentralised platforms employing smart contracts (where failures emerge in the form of asymmetric power relationships such as opportunism and moral hazard), while the latter is mainly the case of originally dedicated infrastructures such as bitcoin (where failures are mainly understood in the form of incoherent states deriving from inconsistent semantics as in the case of the double-spending problem).  

In conclusion, it is important to understand whether blockchain is a decentralised technology enforcing and executing digital contracts or a decentralised technology establishing and enforcing digital property rights: its nature, goals and features, characteristics and purpose dramatically change in the two cases. 

In fact, they are reversed and conceptually antithetical. What we expect from the technology and how we understand the technology (and its problems) may change in function of how we understand the tokens and digital claims transacted over it and enforced by its protocol: whether digitised (smart) contracts between two peers, or digitised property claims among all peers. 

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