Many people have a hard time getting their heads around the new field of crypto. They may say things like “It’s not backed by anything!”, “There’s no regulations or rules!”, and “It’s a scam!”. To a certain extent they are right. In order to really understand the potential of crypto, you need to understand social contracts and the role crypto plays in those contracts. In this article, I’ll explore how social contracts are related to money, smart contracts and blockchains.
What are Social Contracts?
Social Contracts are the enforceable agreement between individuals, governments and corporations. For example, when you go to the grocery store, pay money to the clerk for your groceries, there’s an informal contract. In this case, between you and the grocery store clerk: exchange for money, the ownership of those groceries is transferred to you. More formal contracts are written, such as laws and terms and conditions (which most people blindly agree :). In any enforceable social contract, there’s usually some authority involved, a government body or a corporation. The core philosophy behind crypto is to decentralize social contracts, such as money using cryptography and distributed computing.
Money as a Social Contract
One of the most important economic inventions is money. In this contract, there’s agreement that money (in whatever form) can be used for economic activities, such as buying groceries, selling stock, and lending. For instance, the US dollar in their physical form is an item that can be traded for goods and services. Moreover, the US Government will enforce that contract by managing the physical money, regulations of corporations/banks, and individuals. As you can guess, the decentralization of money in crypto means that there’s no one entity that will manage, regulate or enforce that contract. Bitcoin is the first decentralized social contract, money in particular. The enforcement of the social contract is in the code that are executed by the nodes in the network. For identifying the actors in the network, cryptography is used. The history of the transactions are stored in the blockchain, which is essentially just a linked list of blocks where each block contains a set of transactions.
Social Contracts in Cryptocurrencies
As you can imagine, there’s some differences between the decentralized social contract vs the centralized social contract that we follow everyday. First let’s go over similarities. If you use some payment app such as Venmo or PayPal, you can use your app to pay for products and services. In this case, Venmo and PayPal are centralized. If you were to pay with Bitcoin instead, the user experience would be similar. You have to have some balance of money in your account/wallet and you can send that to someone else. This is where the similarity ends.
With cryptocurrencies, there’s no central entity that keeps track of your balance, providing you with the security that no one can spend your money without your private keys. Not only that, no one can prevent you from sending your money, i.e. cannot be censored. The properties of security and cannot be censored properties of crypto is provided by consensus algorithms across distributed nodes in the network. Therefore, the enforcement of the social contract is distributed. Moreover, these distributed nodes also store the transactions permanently. No one can rewrite previous transactions.
Like any social contract, there are some presumptions or trust that all parties have in crypto. If these were to be false, crypto would lose trust and therefore break the social contract. First, there is trust inherent in cryptographic algorithms. Most of these algorithms presume that using the current computational power, it would be impractical to break the encryption. One of the biggest concerns is quantum computing. If this field takes off, the compute power is expected to increase to such a degree that currently used encryption would be broken. This means that anyone with access to a quantum computer can break the encryption, accessing any wallet. Thus, breaking the security property of cryptocurrencies. The second presumption is that no one entity has control over 50% of the nodes. If an entity had that control (aka 51% attack), they can create any transaction and validate it themselves. Again, trust would be lost if someone could add or subtract anyone’s balance. So there are some fundamental presumptions that can break the trust of crypto social contracts and make crypto worthless. Exercise for the reader: what presumptions exist in centralized social contracts?
So far, I have presented how crypto is decentralizing social contracts. As the trust grows, adaptation of crypto for social contracts will grow as well. The first step towards this direction was money as a social contract. Nowadays, money is in the form of numbers in your bank account. It was a pretty small step to create some sort of digital money that was already happening in the form of money in games (such as Robux) and gift cards for stores.
In the second phase, social contracts around digital assets were added to crypto, as smart contracts that enables Non Fungible Tokens (NFTs). NFTs essentially create a limited supply or unique digital items that exist digitally. Essentially, NFTs create scarcity for digital products that can be copied easily otherwise. NFTs do not prevent someone from copying the digital products. Instead, you have the “certificate of authenticity” of owning it. This essentially enables crypto social contract around who owns what.
Metaverse with NFTs such as Sandbox and Decentraland, anything in these games can have NFTs to track owners of character names, skins, furniture, land, buildings, etc. As more creators make unique digital products and can be used in various websites and games, the adaptation of crypto will just increase.
Another field that’s been added to crypto in phase 2 is financial instruments, aka Decentralized Finance (DeFi). Over the years, the financial institutions have developed lending, margin trading, futures, bot trading, etc. Many projects and exchanges have been adding these financial instruments to crypto. I would expect that this trend will continue going forward. This means that there will be boom and busts as with any new financial instruments.
These transitions makes sense in hindsight. Those enthusiastic about crypto are also gamers. So applying crypto in that field is the most natural progression. Similarly, cryptocurrency is a major use case for crypto and therefore existing financial instruments can be created for crypto. Then, what’s next? I believe the next phase (phase 3) is to add decentralized cloud services. Using the same logic, many crypto enthusiasts would work with cloud computing services (AWS, Azure, Google Cloud). Moreover, there’s an excess of computes and storage everywhere. For instance, many people have computers and mobile devices that are not used 24/7. Each device also has unused storage and bandwidth. Some crypto projects leverage these under utilized computer resources, such as Flux (compute), Storj (storage) and Presearch (search). Check these out to see how the early stages of these utility crypto projects are decentralizing the cloud.
As phase 3 develops, other tech companies will continue to adapt crypto as payment for products and services. First, it was ASIC miner manufacturers or services that accepted crypto. Other tech companies are slowly adapting crypto. As more of the economy starts to accept crypto as payment, the market cap of crypto will increase. What is happening now is similar to what happened in the early 2000’s with the internet boom but at a faster rate.
Beyond phase 3, the trend will continue to 1) Create social contracts enforced by smart contracts for things that were impractical before. 2) Slow adaptation of existing social contracts to smart contracts. First, the low barrier to entry for creating crypto social contracts will identify novel digital products and services using crypto.
For example, the color.museum is minting colors so that any graphic NFT using those colors will split some of the transactional costs of the NFT. This type of contract would not be practical without crypto. Let’s work through how this might work without crypto. Some entities, such as a paint company, could sell colors and for every paint sale, they would split the profits with the color owners. The accounting required would become impractical. Attempting to track the transaction fees of a painting or other product sales to distribute among the color owners would be impractical. How do you track every sale of products that use a particular color?
With crypto, you can employ smart contracts that can execute this type of financial logic. That is, for every NFT transaction, you can calculate the percentage of the image uses that color and then split some portion of the transaction fee among the color owners as recorded in the blockchain. Furthermore, anyone can audit the transactions on the blockchain to ensure that everyone got what they were supposed to according to the smart contract.
Relatively speaking, crypto is still a young field after 13 years (as of 2022). The adaptation of crypto is still in its early stages and more development is required for it to live up to its potential. The first phase was an experiment in using crypto for decentralized money as a social contract. As part of Phase 2 in 2021, we saw a boom in social contracts in the form of NFTs. In Phase 3, we’ll continue to see crypto applied in other tech fields, such as cloud computing. Eventually, other social contracts such as real estate, securities, etc. will be using crypto. However, the centralized social contracts need to be updated to account for the decentralized social contracts. That is, laws and regulations need to be updated so that crypto and existing social contracts can interact with each other. As you know, these types of changes take time.