Nick Szabo: Smart Contracts and the P2P Economy

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Nick Szabo recently spoke at the World Crypto Economic Forum (WCEF) in South San Francisco, CA. Nick is a pioneer in the evolution of blockchain, smart contracts and cryptocurrencies. I’ve uploaded the audio, although the sound quality is only as good as I could capture on my iPhone and attached mic. My summary of his talk is below. Nick can be reached at @nickszabo4 and his popular blog is called Unenumerated.

Human Brain Evolution

Szabo took the stage to a well-deserved round of applause from an audience aware of his long career and many contributions to the crypto and blockchain space.

He started off his talk with a review of a study that examined the relationship between primates’ brain size and number of individual relationship they could maintain in their social grouping.

Our “monkey brains”, as Szabo referred to them, have evolved to support a much larger neocortex than any other primate. But why should we care about the neocortex size? Because it is the part of the brain through which we keep track of relationships; the larger the neocortex, the more relationships we are able to manage.

Sporting a robust neocortex allows us to maintain relationships up until the group reaches about 150 members, Szabo stated. However, when organizations grow larger than 150, our brain’s ability to scale breaks down, new members do not feel as tightly connected and the group is not as effective.

Analysis of group sizes throughout human history supports the 150 member limit. The average size of groups in ancient hunter-gather societies is around 148. The size estimates of neolithic villages in Mesopotamia is also around 150.

(I sometimes get lost down rabbit holes when researching a blog post. If you’re interested in more information on the evolution of human physiology, you can read this article on How Humans Ended Up With Freakishly Huge Brains.)

Modern society has developed entire categories of professions dedicated to enhancing social scalability, Szabo pointed out. Advertisers, marketers, business development, sales people help us get to know other people, products and services that may be outside of our social group, he noted.

Economic growth in human societies was greatly enhanced by the concept of the market, Szabo explained. This is described by Adam Smith in The Wealth of Nations as a web connections that enhance deal-making. The development of the division of labor was also an important factor.

According to Szabo, deals between humans can be broken down into four components:

  • Search – locating deal partners
  • Negotiation – agreeing on the terms
  • Performance – delivering what we promised in the deal
  • Post-performance – adjudication, reputation rating

Tremendous innovation has occurred as companies appeared that focus on the search component and facilitate matching buyers with sellers, he added. Google, eBay, Amazon, Uber, Airbnb all match strangers with each other so they can interact and engage in specific commercial activities.

There are limitations on the implementation of these components, Szabo asserted, which can be illustrated by looking at some of the weakness in the Bitcoin ecosystem.

Bitcoin is one of the most secure financial networks on the planet, Szabo claimed. Even so, there have been incidents where hackers exploited a known vulnerability in the way the Internet functions to steal from Bitcoin miners. This method is called a routing attack which is designed to slow or stop communications between major parts of the Bitcoin network so that duplicate transactions can be submitted. The technical term is BGP (Border Gateway Protocol) hijacking or IP (Internet Protocol) hijacking.

The decentralized nature of the Bitcoin architecture only means that there is no central authority (like a government or bank) in charge. But from a networking point of view, Bitcoin’s architecture is largely centralized because there are only a few Autonomous Systems that host most of the nodes, making them susceptible to these kinds of communication-based attacks.

Szabo described that the exchanges that interface Bitcoin with fiat currencies are insecure and vulnerable to hacking as we saw with Bitcoinica in 2012 (46,703 BTC), Bitfinex in 2016 (119,756 BTC) and the largest hack of all at Mt. Gox in 2014 (744,408 BTC). Even though Bitcoin offers a secure method for issuing money, the peripheral systems that manage interactions still have some work to do, he noted.Nick Szabo

Over the past century or so, we have seen exponential growth in the computational capabilities of computers, creating a surplus of resources, Szabo observed.

It was this computational surplus that enabled Bitcoin to become feasible. Public blockchains can handle what were formally computationally expensive tasks such as mining, broadcasting messages, and replicating transactions across a global network.

Blockchain is the first secure, self-sufficient information system, Szabo proposed, since it does not require support from trusted third-parties like system administrators.

For tasks that can be automated, such as issuing new currency and settling it around the globe, software can replace the non-scalable, human bureaucracy that is required for handling fiat currency, he asserted.

Why Make Smart Contracts?

When two strangers who do not trust each other want to make a deal, they have to contract with a middleman. This could be a broker, lawyer, bank or any other intermediary. The middleman documents the terms of the contract and ensures that it is executed fairly. Szabo called this traditional form of contract “wet code,” since the terms are interpreted by a human brain.

The value of smart contracts is that same two strangers could consummate a deal on a blockchain without anyone in the middle. Szabo referred to this as “dry code,” since the terms are interpreted by software. (Szabo first discussed wet versus dry code on his blog back in 2006!)

Wet vs Dry Humans Software
Logic grounded on Subjective minds, analogies Boolean logic, bits
Security Courts, police Replication + cryptography
Predictability Flexible Rigid
Maturity Advanced, Highly evolved Larval, Few cases

The concept of an objective rule of law that is not based on human whims is not a new concept, Szabo stressed. The Founding Fathers enshrined it into the U.S. Constitution.

Szabo was not too kind to the SEC’s recent “wet code” rulings regarding the Initial Coin Offering (ICO) market. He referred to the one that said TheDAO tokens were actually securities, not utility tokens, so they were breaking the law by not registering them. However, the agency did no actual enforcement beyond sending out a warning letter, which was only to “scare people,” he insisted.

“A strong doctrine of immutability minimizes the control of human whim over our money.”
— Nick Szabo

While there are around two million programmers in the US, only as a small fraction have the knowledge to develop reliable blockchain programs, Szabo insisted. There are more than five million accredited investors in the US, but almost no overlap between the two groups, he noted.

To enable more people to be able to setup deals on the blockchain, Szabo’s company is working on a framework to allow non-programmers to create smart contracts.

Smart contracts can be negotiated and customized and both parties can create an offer, accept or reject it, or revoke the contract.

“Smart contracts allow creation of pairwise deals that form a spontaneous network and P2P micro-economy across a blockchain.”
— Nick Szabo

Implementing blockchain technology is like cutting through a Gordian Knot and allows separate parties in different parts of the world to create secure, reliable smart contracts across industries such as finance, logistics, manufacturing and others.

Smart contracts will take some time to evolve until they are more widely utilized and will continue to improve, Szabo believes. His company is working on new decentralization technologies that will overcome some of Bitcoin’s current limitations that have resulted in high transaction fees and slow processing time.

The advances include atomic swaps to assist with more trust-minimized exchanges as well as second payment payment channels such as Lightning and Raiden that are trust-minimized ways to perform transactions and expand computational scalability.

If you would like to hear more about and from Szabo, I highly recommend listening to this fantastic interview of him by Tim Ferriss.

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