Original Link: Incomplete Contracts and Blockchain

Author: Cathy Barrera, PhD

Summary & Commentary

The study of Contract Theory highlights how contracts, a fundamental part of economic activity, are inherently incomplete due to the impossibility of accounting for all possible contingencies and verifying all actions. This inherent incompleteness presents a unique opportunity for blockchain technology.

Blockchain startups should focus on:

Improving Quality of Information: The smart contract technology in blockchains allows for automated execution of agreements. However, the major gain is not in automating the execution of verifiable terms, which traditional institutions already handle relatively well. Instead, the most significant efficiency gains can be realized by improving the quality of information so more terms can be included in contracts.

Actionable Insight: Blockchain startups should consider how they can utilize technology to make more information verifiable. For instance, in the insurance sector, telematics devices can verify driving behavior, which was previously unverifiable.

Expanding Contingency Coverage: Technology can help broaden the coverage of contracts, making them more complete. Artificial intelligence (AI) and big data could potentially be employed to predict and account for a wider range of contingencies.

Actionable Insight: Invest in predictive technologies like AI and machine learning to identify and manage possible contract contingencies better.

Coping with Incomplete Contracts: Rather than trying to make contracts complete, which is unrealistic, startups should focus on establishing measures for dealing with the inherent incompleteness of contracts.

Actionable Insight: Establish procedures for dispute resolution and contract amendment. Make use of the transparency and immutability of the blockchain for recording any changes and resolutions.

Maximizing Enforceability: Since contracts are only as good as their enforceability, startups should focus on ensuring the enforceability of contracts by leveraging blockchain's inherent transparency and security features.

Actionable Insight: Blockchain projects should be designed in a way that they maximize the enforceability of contracts, ensuring that the system does not become a bottleneck but an enabler in the enforcement process.

The combination of blockchain technology and the principles of Contract Theory offers a new pathway to reshape our transactional relationships. Blockchain can go beyond merely facilitating transactions to revolutionize the core functioning of our contractual systems. However, for that, we need to focus on the inherent incompleteness of contracts and how blockchain can help address this limitation.