The crux of this post is a call to attention that the rise of the blockchain poses unique challenges to the judicial system. I write this not in the belief my arguments and conclusions are necessarily correct, but with the worry that it's an issue we should cover sooner than later. If economic prosperity is premised on sound property rights and well functioning courts, then to drink the Cool-Aid we must also consider what is to replace a withering judiciary. Transaction immutability, we shall see, the very principle held most dear to the community, lies at the heart of the issue. But before delving there, let us back up and consider the basic components of any transaction.
Trust Multifaceted in Transactions
It's easy to forget, but whether bartering, or exchanging a good or service for currency, there are always at least 2 types of items being exchanged in any given transaction. Each type of item exchanged introduces its own type of risk. Is the gold real? Are the apples rotten? Is it counterfeit money? Is the title clear?
The issue of trust (the other side of risk) presents itself not just in the examining the quality or provenance of the goods/services being traded, but also in how ownership is conveyed (or transferred--IANAL but am taking liberties with the real estate law sense of convey).
Traditionally, the state has acted as a sort of guarantor in various capacities in a well functioning marketplace. Indeed, the minting of hard-to-forge currency can be seen as a means for facilitating trust on the monetary side of transactions.
Ownership Records
But that protection does not extend to the goods/services being purchased. For these, we largely depend on evolved structures and institutions. Ownership in certain asset classes (such as land) has historically been recorded, and in modern times the state has assumed the role of recorder of many a such asset--real estate, vehicles, come to mind. In other cases, this recording is delegated to existing evolved institutions in the marketplace. Here in the US ownership of shares in public companies, for example, is recorded with an independent entity, the transfer agent--or at the brokerage house (in so called "street name"), if held in a margin account. And for centuries across bazaars in the middle east, wholesale goods in storage have often changed hands only in book entry form.
Regardless how (and whether) property is recorded, the power of the state to intervene and transfer the ownership of property (usually not to or from itself) is implicit in the marketplace. Indeed, it is generally (if implicitly) understood that property rights are rights granted and protected by the state. In well functioning market economies (not necessarily democracies) this power is exercised both sparingly and judiciously. While most transactions clear without its direct involvement, the state (usually through its judicial arm) intervenes in a minority disputes. Ultimately, the exercise of this power rests in the state's ability to force property records (whether private or public) to convey ownership. And these records also include those of financial assets and currency.
Blockchains: Code as Law
The rule of law has always been essential to the proper functioning of the marketplace. If the traditional interpreter and arbiter was the judiciary, the new interpreter of contracts and law in the crypto-economy is code. This new interpreter is guaranteed to be impartial. It follows the rule book to the letter, and its records are final. Moreover, neither it nor any sovereign can force a change to its records to convey ownership.
In the land of Code as Law, the only remedies are legislative: an amendment to the rule book. Legislative measures, however, usually target classes of stakeholders; they seldom address individual transactions and in any event cannot scale to remedy any significant number of transactions in dispute. An example of such a legislative fix was the Ethereum fork to undo the DAO heist--of which I griped about here.
Caveat Emptor: Mixed Legal Regimes
A transaction involving the purchase of a good or service with bitcoins, then, falls under two separate and independent legal regimes. On the buyer's side, the conveyance of the goods or the performance services purchased is governed and protected under the local laws of the state or relevant jurisdiction. On the seller's side, however, currency is conveyed under the Code as Law regime. Because neither regime can ultimately force the other to change its property records, the two legal regimes are largely disjoint.
From a theoretical standpoint, jurisdictional power enjoys a slight upper hand over Code as Law. While in the face of a court judgement an individual may be unwilling to give up their secret key in order to, say, return ill-gotten bitcoin gains, the state can still induce cooperation by depriving them of liberty.
What about smart contracts? Here, jurisdictional power seems to enjoy a bigger advantage. In the event a smart contract conveys ownership of, say, a hard asset, the state (again, usually through its judicial arm) may potentially overrule the new record of ownership (title) on the blockchain. Same if it involves an exchange of financial assets (such as shares in a public company). And this fact, in turn, clouds the authority of records on blockchains that reference assets that ultimately fall under the purview of the state.
Returning to the simple purchase of real goods using bitcoins use case, the risk asymmetry for buyer and seller is accentuated. Consider the following: would you feel more comfortable buying from a vendor who deposits your money at the local bank or one who immediately wires it to an account in the Cayman Islands? Buyer be wary.
Remarks
I am deeply skeptical that any system of commerce can prosper without the protections of a functioning judiciary. If commerce is to extend to the blockchain, then the blockchain must offer something in place of the courts. And if it does, then its records cannot be immutable in the strict sense we have espoused.
Let us then contemplate how a judiciary on a blockchain might work. If no transaction is ever [effectively] final, then perhaps there are a set of cryptographic keys that can override all others. One approach that comes to mind is to employ a proof-of-stake (PoS) strategy for constructing a blockchain. Some PoS protocols leave out how the initial stakeholders come to be: Algorand is an interesting recent example. What if a central bank were to issue crypto coins backed by fiat currency? That would take care of bootstrapping the initial stakeholders (anyone holding the pegged fiat currency would be provided a mechanism to be a stakeholder). Also, there might be special keys held in trust by the courts, that are collectively empowered to override all others. Just how the state manages [not to lose] its keys is obviously an open question.
Yes that is a perversion of the trustless, decentralized ideal. But what if the ideal is impractical? What if we are forced to build the analogous trust hierarchies on the blockchain as have already evolved in the real world?
And why would a sovereign consider issuing coins this way, besides? Perhaps because it couldn't risk being second.
