One of my majors in college was international politics, and among the course requirements were a number of classes on game theory. It was one of the most interesting parts of my coursework, but I am sure I wouldn’t have believed it if I’d been told that a few years later I’d be spending an afternoon, of my own volition, writing about using the Bitcoin protocol to create assurance contracts.
The free rider problem in game theory posits that there are situations in which the creation of a public good (for example, building a road) will provide utility to a group of people and leave everyone better off. However, if there is no way of excluding those who did not contribute, many will make the rational decision to not pay and yet still reap the benefits of others’ contributions. In some cases this means that the public good will not be created, and utility is lower for everyone. Assurance contracts represent a way of solving the issue by ensuring that people actually contribute. In one of these binding contracts, a group of people agrees to fund a certain public good when a financial threshold is met. If the project is fully funded, the public good is provided, and if it is not, then the money is returned to those who pledged it.
Another interesting twist is the ability to create dominant assurance contracts. In game theory, a dominant strategy is one that is the best course of action regardless of what the other actors in a scenario do. In an assurance contract situation, a dominant strategy would involve having the entrepreneur agree to pay a certain amount of money back to the contributors in the event the project wasn’t funded. Although this increases the risk for the entrepreneur, it also increases the probability the project will be funded. For the potential contributors, this setup ensures a win-win situation, where funding the project is always the best strategy – they either get the good, or their money back plus some. I won’t go into great depth about creating dominant assurance contracts with Bitcoin here, but if you’re interested here’s a solid explanation.
The binding nature of the assurance contract dictates that there must actually be someone enforcing it. This has historically been a third party like a government, a mediator, an escrow service, etc. Reliance on a third party can be problematic in a number of ways, among which the fact that there’s not necessarily a way to ensure they will operate fairly. In international scenarios involving multiple countries trusting one another, there’s no greater power who can offer that assurance. (The UN was supposed to offer this, but sadly it holds very little real power – consider that in 2010 for instance, only 13 of 193 countries paid their dues on time, and the US itself owed roughly $1.2 billion in arrears.) In situations like this, having an independent arbiter would be key — and better yet one that is not corruptible and technology rather than human-based. Enter the Bitcoin protocol.
The basis of crowdfunding platforms like Kickstarter and Indiegogo is the same – they operate as the third party who collects funds from backers and then releases money to the project creator when the threshold is met. With Bitcoin, the need for a third party is removed and the process can be handled by the technology.
Here’s how it would work:
The Bitcoin protocol has several properties which make it perfect for crowdfunding and render the above steps possible.
**One thing to be aware of is that the transaction isn’t actually spent until the total threshold is met, so contributors have to be careful not to forget about it and accidentally spend the same transaction twice.
Applying the Bitcoin protocol to assurance contracts and crowdfunding allows us to abstract to technology what could be a very manual process of collecting funds. It removes the roadblock of finding a shared, trusted third party arbiter, which can be particularly difficult – if not impossible – in tense international scenarios, and undesirable in other cases as well. The most incredible thing about it is the enormous range of instances in which it can be used – literally from raising money for a third grade field trip to accepting international contributions to build a refugee camp in a war-torn region. I’d say that’s some legitimate added value — not bad for fake internet money!