The Rise of Smart Contract and Its Complex Impacts on the Digital Ecosystem

Abstract

Nowadays, we are forced to join in a more and more complicated contract and a faster and faster transaction in the market. We are also seriously faced with security problems. As the society evolves, the related systems generally become complicated. The economic system, more specifically, the market system is not exempted from this law. This exactly means the advent of a new formula of it currently corresponding to the extent of complications. Without any incessant improvement of the digital technologies, our performance would not be smoothly achieved.

Given an idea of smart contract, blockchain becomes a broader computational technology to realize a set of smarter systems/transactions associated with the Distributed Ledger Technologies (DLT). Such a well-known instance is the smart contracts on the Ethereum platform, that is associated with account information each. The smart contract tied together with DLT actually enables to design an economically well-behaved set of Peer to Peer (P2P) system, which ranges over from the micro market to the international currency transaction system. The introduction of this technology may suggest what a truly decentralized future is. This must cast a new light on the problem how to design either auction or vote of P2P, i.e., without auctioneer or chairperson. Either of them will possibly mean the change of existing social consensus.

The DLT originally was designed by the presumption that someone always is malicious, as Byzantine Generals Problem suggests. The programming of smart contract is written in Turing complete language. A smarter solution against a complicated system actually then requires a stronger security against their vulnerabilities. Thus, the diffusion of blockchain technologies into the contract systems will demand a fully protective infrastructure. As Stephen Wolfram suggests, furthermore, “[a]s the number of DLTs grows, it becomes harder and harder to learn and build ecosystem tools to make monitoring transactions, smart contracts and services possible.” In other words, the diffusion of blockchain will bring newly some coordination problems as well as the new statistical examinations.

In this paper, after looking briefly the current features of digital contract, we will argue some evolutionary impacts on the digital ecosystem in the context of either smart contracts on the Ethereum platform or the Byzantine Generals Problem.

1 The Landscape of the Modern Socio-Economics System

The new century has already passed by the first 1/5th time window. Compared with the last century, the socio-economic system essentially is evolving, in particular, geometrically in the sphere of digital technology, which could replace the traditional dominant governance with a new one. It will take much time to examine the detailed process currently running. So we like to depict a rough sketch of the landscape on the current configuration of digital technologies wired to our socio-economic system. Here we focus on the difference of speeds around the digital technologies suited for economic transactions.

Fig. 1.

The landscape of the socio-economic system in view of different speeds

Table 1. The input-output table of 13 sector, 2015, Japan at production prices *cited from 2015 Input-Output Tables, e-Stat, Portal Site of Official Statistics of Japan: https://www.e-stat.go.jp/en/stat-search/files?page=1&layout=datalist&toukei=00200603&tstat=000001130583&cycle=0&year=20150&month=0

1.1 The Separation of the Financial Transaction from the Real Economy

As shown by Mirrowski (2007), the standard implication of the original market is lost when the market is layer-structured by generating markets on the original market. The financial market since the so-called financial Big-Bang, as characterized by generating derivative commodities, are typical of hierarchical markets. In particular, in the latter market, a self-organizing growth has been implemented. This implementation has promoted more and more to separate relatively the real market from the financial market. Thus the stock prices have been inactive/sluggish against the changes of the real economy but rather reactive excessively to political issues. In this point of view, the world is divided into two distinct domains which mutually are partly disjoint but incessantly influential. It is noted from Table 1 that the contribution from “Finance and Insurance” industry to GDP merely is 3.2% in Japan and the like¹. If the prosperity in the financial domain should be directly wired with the real domain, GDP could be much more increased.

1.2 The Hyper-speed Domain

We firstly exposit the first upper part of Fig. 1. This diagram is depicted by taking notice of the different speeds of the transaction roughly divided into two domains: the domain dominated by the hyper speed and the other one by the slow speed.

During the last decade, the high frequency transaction, i.e., HFT, has been dominant. After Lehmann shock, there happened a flash crash firstly in 2010², which implies an instant crash of stock prices, accompanying a quick counterbalancing restoration of the prices. Hyper-acceleration of the order speed is making the occurrence of flash crashes invisible. However, this could not remove flash crash but moreover spread to the currency market.

This observation may call us “the relaxed static stability”. Depending on the idea of “fail safe”, structural stability has been important in designing planes and ships up to now. On the contrary, a modern stealth fighter like Lockheed F35 is designed by the idea of relaxing “static stability”. It is well known that bicycle behaves much more quickly than tricycle, and tries to restore its instability by resort to its counter motion. The counter motion will be controlled by computational powers. Thus we expect that some nonlinear effect is implemented behind the flash crashes, always accompanying a countervailing power. So we demonstrate the nonlinear force working in the hyper-speed domain.

Within such a hyper-structured hierarchy, the working of each market can only be examined by computer simulation. However, there is little sign that economics tries to solve this problem. The advent of HFT has led to the settlement of microsecond payments, which means that the order speed and the physical distance between the order terminal and the transaction server can dominate the settlement. The continuous double auction depends on the double priority principles of time and price. Usually, the time principle is preferably applied. Thus the physical speed of order, instead of economic motivation, dominates the settlement. Under the HFT, the economic meaning of the auction rule has been then considerably changed. Even the traditional stock market rule of membership has virtually been altered by the lending of high-performance servers in the stock exchange.

1.3 The Slow-Speed Domain

Secondly, we examine the second domain of Fig. 1. This is relevant to the main interest of this paper. In contrast with the hyper speed domain, it matters “the slow speed” to employ blockchain technology³. Here the word “slow” may be interpreted as “non-hyper-speed” or “non-microsecond”. In view of a certain scaling, blockchain may be enough speedy excepting the mining speed of Bitcoin. In this sense, it is easy to identify the crypt-currency using blockchain technology with a slow speed technology. More interestingly, there currently is existing a world wide nodes network at the basis of P2P transaction.

It is noted that a large-scaled network system of P2P mode actually is working, as the live node map in Fig. 2a shows. It is also noted that a P2P network, due to its own attribute of P2P mode, will take much time for propagation of any value transfer, as Fig. 2 shows.

Fig. 2.

Node distributions

2 A Simple Design of Auction on the Ethereum Platform

2.1 The Distributive Ledger System of the P2P Type

In our argument, the distributive ledger system matters. This system is as usual compared with a centralized ledger system, shown in Fig. 3. Here the process is intermediated by mining process using the Hash function, as the table below of the system above. In the former system, key and ledger are managed by the central authority. However, in the latter system, they are distributed and managed by each entity.

Fig. 3.

Centralized network and distributive ledger system of the P2P type

It is noted that blockchain is not a technology only simply for crypt-currencies. Blockchain is also used a censor technology, e.g., in order to retrieve a defective lot in a factory system of the manufacturing industry. Even if a block chain technology is to be applied to the financial field, its usage is not limited to crypt-currency like Bitcoin or Ethereum. If you turn your eyes to finance, you will see two perspectives on the use of blockchain. When talking about blockchain, naturally, we suppose permission-less mining process. However, we can also establish a permission-ed mining process. There are actually somewhat a hybrid form to use blockchain within the permission-ed framework, like Libra by FACEBOOK. Among them, we note the IBM blockchain applied to the currency exchange, which provides the financial institutions with a better opportunity by way of a world wire network (API): either € or $ are transformed into “a stable coin” as the digital asset, which can achieve a simultaneous exchange between the two. Here messaging, clearing, and settlement for the desired exchange will be integrated by blockchain technology without falsifying bookkeeping. The latter usage may be classified into a hybrid application of blockchain in a sense that blockchain is incorporated as a sub-system of the currency exchange. This kind of usage of blockchain will also improve the transaction efficiency.

In this section, we will argue other examples of blockchain like auction⁴. Furthermore, we may also refer to the decline of local communities shown in Fig. 1. The decline of local communities are still in progress during the modern process of expanding inequalities of income and wealth. Needless to say, at this moment, the field to establish a local currency peculiar to its local community may be also one to be applied by blockchain technology to promote the transactions of its local community more efficiently.

2.2 Smart Contracts on the Ethereum

In 1993, Nick Szabo described how users could input data or value/then regain from the transfer system as if it were a digital vending machine. Ethereum shares the same function as Bitcoin in a sense that the network can transfer value from one to another. Different from Bitcoin, Ethereum, provides each node with additional information account, which could function as the distributive ledger for each, while Bitcoin only transfer the value of currency.

Ethereum is called a system written in Turing complete language⁵. As a Turing Complete system means a system in which a program can be written that will find an answer, Ethereum, if it is, allows to program autonomous agents. The contract will be called smart contract⁶.

• Smart contracts are fulfilled with multi-signature accounts, which imply that “funds are spent only when a required percentage of people agree”.

• Smart contracts can manage agreements between users, say, if one buys insurance from the other.

• Smart contracts provide utility to other contracts (similar to how a software library works).

• Smart contracts can store information about an application, such as domain registration information or membership records.

In other words, thus, Ethereum becomes a platform suited for creating smart contracts. Hence, using Ethereum platform, if they use a smart contract, users can send 1 ether to their friend. A rough sketch of the smart contracted transaction system based on the Ethereum platform will be depicted as shown in Fig. 4.

Fig. 4.

Smart contracts on the Ethereum platform

The idea of smart contracts will be applied to a simple auction of P2P type.

2.3 A Simple Design of Auction on the Ethereum Platform

In order to spare the time for exposition, firstly, we depict a flowchart of a simple auction on the Ethereum platform. We suppose the auction to be 1 owner and 3 bidders in our simple auction. Correspondingly, 3 accounts/ledgers each bidder. An elementary process of P2P auction will be designed as follows:

$\langle$1$\rangle$:

Generation: Owner asks their bidders

$\langle$2$\rangle$:

Bidder 1 bids 1 ether;

$\langle$3-1$\rangle$:

Bidder 2 bids 2 ether

$\langle$3-2$\rangle$:

Bidder 1 refunds 1 ether

$\langle$4$\rangle$:

Malicious Generation $\langle$Bidder 3$\rangle$ generates 3 ether

$\langle$5-1$\rangle$:

Malicious Bidder bids 3 ether

$\langle$5-2$\rangle$:

Bidder 2 refunds 2 ether

$\langle$6-1$\rangle$:

Bidder 2 bids 4 ether

$\langle$6-2$\rangle$:

Bidder 3 refunds 3 ether

$\langle$7$\rangle$:

An infinite loop will be formed .........

The flow described above will be depicted in Fig. 5. Due to an intermediary of Malicious Generation, Bidders may be induced to give a higher bidder. In order to interrupt a chain reaction, the process $\langle$6-1, 2$\rangle$, by mining, is indispensable.

Fig. 5.

The design of a P2P auction taking notice of malicious bidder *The chart was originally produced by referring to Fig. 10.1 of Takago (2017).

It is noted that the auction above is of P2P type. It is interesting for us to mention two important remarks around the auction on Ethereum platform. Due to the P2P attribute, there no longer exists an auctioneer at Exchange⁷.

Malicious trader:

P2P can work well autonomously without any coordination of a centralized management. Instead of an auctioneer, the verification process of transactions by mining is indispensable. So, firstly, we remark that the most important designing strategy is placed on removing the kinds of malicious bidder in the kind of P2P auction.

The second remark will come out from the use of blockchain. We cite an important remark from Manski (2017):

Blockchain technologies are reconfiguring the global economy, though often in contradictory ways. Blockchain technologies are disrupting key economic and financial sectors. Some blockchain applications allow for democratization of finance, services, agriculture, and governance, yet they may also deepen inequality and weaken democracy. We need new understandings of the countervailing tendencies of blockchain technologies and the contingencies that shape their deployment.

3 Byzantine General Problem

3.1 Common Knowledge

It matters for years in social science and coordination problems that how common knowledge does exist. Common knowledge is formed only after there is a unique signal that is recognized by each other, as Schelling (1960) argued⁸. As shown in the last subsection, the existence of malicious will will disturb/prevent from forming Common Knowledge Rationality, which is not premised on malicious intent, because all agents should be reasonable/rational.

On the contrary, man who is born malicious can lie. Thus common knowledge in human communication is always exposed to falsification. Interestingly, this kind of danger/risk also applies to information transmission of a machinery system. In this case, accidental faulty transmission will play a role of human lier. It may be easily verified in the two party message to observe a propagation of a new message. Figure 6a indicates a unique transmission of message emanating from a node. While Fig. 6b indicates a mutual formation of a value system of the network.

Fig. 6.

P2P propagation of faulty and non-faulty message in the two party message system

3.2 Where the Problem Is

In the following, we will discuss the so-called Byzantine General problem. This problem has been already solved by Pease et al. (1980). This paper smartly “where the problem is” as follows:

[The Byzantine General Problem] addressed a set of isolated processors, some unknown subset of which may be faulty, that communicate only by means of two-party messages. Each nonfaulty processor has a private value of information that must be communicated to each other nonfaulty processor. Nonfaulty processors always communicate honestly, whereas faulty processors my lie. The problem is to devise an algorithm in which processor to infer a value for each processor. The value inferred for a nonfaulty processor must be that processor’s private value inferred for a faulty one must be consistent with the corresponding value inferred by each other nonfaulty processor.

In short, the Byzantine General Problem implies that “when a consensus is formed on a decentralized network, if there is a malicious person, it is impossible to form an agreement that can guarantee reliability”. This is a problem that must be solved on a P2P system like a virtual currency⁹. In the following, we abbreviate the Byzantine General Problem as BGP.

3.3 Two Generals Problem

We begin with an elementary problem called Two Generals Problem. There is a fortress that cannot be surrendered by a single attack, and the attack is then designed to be performed by two generals. On topography, the method of communication between two generals is limited to dispatching messengers. Whether or not to perform an attack at the scheduled attack time depends on the content of the agreement between the generals.

We examine a consensus formation among the two generals. It is necessary to communicate with each other, agreeing on the attack time, and confirming that the other party knows the agreement. In order to avoid an infinite loop of consensus formation, we are induced to rank the two generals into the commander and the deputy commander each two.

If we employ the oral messages due to easy sending, we will need more assumptions on them:

• The messages to be send are assumed to be transmitted properly. In other words, rebels cannot interfere with communication between two generals.

• The recipient has right knowledge of the sender of the message. In other words, rebels can’t obscure messages by sending additional messages.

• It can be confirmed whether oral messages can be sent or not. We may promise the default message as “Retreat”, for example. Otherwise, “Attack” will be confirmed.

The commander general then decides the attack time, transmits the message of attack to the deputy commander by dispatching a messenger, and waits for the consent from the deputy army. If a reply is not received, either a messenger’s accident to send or a deputy commander’s betrayal. In general, it is impossible to design algorithms that can be safely agreed.

3.4 Byzantine General Problem and Its Practical Implication

Now we generalize the Two Generals Problem above stated. According to Siddharth (2011)¹⁰, we give a brief profile of the proof on the BGP. In our environment, there are at least the supreme commander and two lieutenant generals.

• If all the lieutenant generals are faithful, they will move with the same action plan.

• If the number of rebels is small, it will not be moved to the opposite plan.

• In order to realize the above, generals must come up with the same plan through the same method of information collection.

Thus it then follows the next statement:

Proposition 1

If no more than 2/3 generals are faithful, no solution can be found. Even with 3 generals, the protocol will not work if there is one rebel.

Fig. 7.

BGP G: General; Li: Lieutenant i

The set of adjacent nodes i categorized by lieutenant name is called regular when the following conditions are met. Each node is an adjacent node of node i. A node that does not belong to the rule set has a route that does not pass through the node i that originates from the node of the set. If any node has a neighbor of p-regular, the graph is said to be p-regular. Therefore, a $3m-$regular graph is defined with a minimum of $3m + 1$ nodes.

In general, the BGP will be stated as the next theorem.

Theorem 1

If there are m rebels, a solution is not found if there is no more than $3m +1$ of the number of rebels.

Finally, the algorithm for detecting the arrival stream of messages will be recursively defined:

• Every lieutenant general forwards the received value to all other lieutenant.

• The supreme commander sends his value to all lieutenants.

• Each lieutenant broadcasts the commander’s order to other lieutenants who have not had the value.

• Next, take the majority function of the received values.

• Index the messages occurring each round by lieutenant name i

In majority voting, throughout input synchronization, every input will be transferred/aggregated into the same decision value. If the input is not faulty, the non-faulty arrival stream will follow the above values. The recipient knows who sent it. A fully connected network is then formed. Given a signed message, the recipient would not need to spend time to know who sent it¹¹. In order to avoid forgery of the messages, however, the message is to be signed in the form of node $i = (M, S (M))$ where M is a message, S(M) is a signed message. The proof of the BGP thus has demonstrated a set of necessary conditions to fulfill a transmission of true messages, using cryptographic operations and modular arithmetic. Hence it has seen that the BGP prepared for the fundamental design information, as well as a justification for verification of the message of remittance by mining blockchains.

4 Concluding Remarks

As we examined an auction system of P2P type as well as the BGP, it matters lies and rebels around human decision. We have seen that the existence of malicious bidder can prevent the auction transaction from working normal. It is quite interesting for us that the BGP theorem does not demand a strict fulfillment of the agreement over all participants. In fact, the BGP proves an extent to allowable failures to fulfill the desired (physical) decision. In the context of machinery system, communication media failure can be viewed as another form of rebellion. The BGP therefore contributed to a realization of the fault torelant system.It is also well known that there are as usual the sample programs of either auction or voting attached in Ethereum package. Not only auction but also majority voting will share the same idea.

In order to implement the fail safe factor into the network system of greater number of nodes, however, it takes some grand idea to keep the working of P2P network almost always fair. This grand idea is just the smart contracts on the Ethereum platform. It is noted that we require a huge but distributive infrastructure to support this idea.

Thus we temporarily sum up our discussion about P2P network here:

• Market is not a given entity but a designed artifact.

• Market is designed at basis of the existence of malicious participants.

• Blockchain is simply a possible mean to achieve a distributive ledger system to avoid risks emanating from malicious wills.

• P2P network, although it guarantees democratic, will be faced with a huge complex relationship of links and nodes beyond human intelligence to be solved by a new technology like blockchain.

• Needless to say, distributed network and distributed ledger will be applied not only to smart contracts but also to local currencies.