A smart contract is computer code that deterministically executes an algorithm to determine property rights according to the signed statements of individuals. They enable a community to efficiently and unambiguously reach a shared consensus on who owns what.

Daniel Larimer described Smart Contracts as an ideal expression of the Title Transfer Theory of Contract by Murray Rothbard. While traditionally implemented on a blockchain, we believe the theory of smart contracts can and should apply to all legal agreements.

ƒractally utilizes smart contracts to govern decentralized autonomous communities and encourages everyone to understand the paradigm shift created when a community builds their governance and dispute resolution on top of the theory of smart contracts.

The following excerpt is from the chapter on “Smart Contracts” in the book “More Equal Animals - The Subtle Art of True Democracy” by ƒractally’s founder, Daniel Larimer.

Smart Contracts

by Daniel Larimer

What is a contract? Why are they binding? How are they enforced? We sign contracts all the time and pay lawyers a ton of money in the process, but how many of us have actually stopped to think about the principles that back contracts? Should all promises be enforceable or only those tied to consideration? Why or why not? The answers to these questions reveal subtle principles that are critical to sustaining a true democracy.

Murray Rothbard and Williamson Evers developed the Title Transfer Theory of Contract, which I believe contains critical concepts for a true democracy. Rothbard’s derivation of property rights is based on the theory of “homesteading” or “first use” and is vastly different from my derivation of property rights as a peace treaty. That said, his theory of contracting relative to defined property rights is still relevant.

While other philosophies claim “rights” as fundamental axioms derived from axiomatic moral stances such as the “nonaggression principle”, I claim that there is no support in nature for their principles. At best, their philosophies amount to a proposed peace treaty. While I reject their axioms as such, I feel that there are ample lessons to be learned from Rothbard’s work about how to design a logically consistent, and enforceable peace treaty (i.e. true democracy).

One of the most important aspects of a peace treaty is to define who owns what, how ownership changes, and how disputes are resolved. Any confusion over ownership creates conflict and conflict is supposed to be resolved by a peace treaty. Therefore, it follows that the peace treaty should define the process by which individuals may contract with respect to their property such that it minimizes ambiguity. This in turn brings up the question of what constitutes a valid contract and how are they to be enforced?

Traditional Theory of Contracts

Before expanding on what that means, let’s review how contracts typically operate today. Contracts are generally combinations of promises “to do” or “to give” something. If you are buying a coffee you verbally contract to give title to cash conditioned on receiving title to a cup of coffee. This contract need not be written down to capture the intent of the parties. This is an example of a “to give” contract. A “to give” contract could easily be represented on a blockchain as a smart contract assuming you created “digital titles” linked to a physical things.

A “to do” contract could be something like an employment contract. Here you promise to work 40 hours in a horseshoe-nail factory next week and someone else promises to pay you cash. In the event you choose not to work it could be considered a breach of contract. In the simple case, you simply don’t get paid; however, in the worst case the “kingdom could be lost”.

For want of a nail the shoe was lost. For want of a shoe the horse was lost. For want of a horse the rider was lost. For want of a rider the message was lost. For want of a message the battle was lost. For want of a battle the kingdom was lost. And all for the want of a horseshoe nail.

Failure to perform on a “contractual” promise can cause grave damages to other parties relying on that promise. When these issues are taken to court under traditional contract theories, the judge will rarely compel you to perform the service. Instead, the judge will usually order you to pay damages to the other party. There is a problem with this, though: what are the damages? How is anyone supposed to know the extent to which other parties rely upon their promises? Would you take a job that promised to pay you $10 thousand dollars to work 40 hours next week, but if you change your mind you own them $10 million dollars in damages? Suppose you get sick or are in a car accident? Let’s assume for a moment that the other party really would experience a $10 million dollar loss without your performance and that this isn’t just a huge and unreasonable penalty. If you knew they were relying on you to the tune of $10 million in damages then chances are you would demand higher compensation in the first place and you would take out insurance to cover any events beyond your control that could make you liable for $10 million dollars.

Wedding Engagement as a Contract

All “to do” contracts are effectively unbacked promises. When you get engaged to be married the courts often consider this a contract. If you are jilted then you can sue for damages and many courts will grant them. The damages could be anything from the cost of the wedding to the loss of a job given up in expectation of getting married. When the parties “agreed to be married” the terms were ill defined and the damages potentially unbounded. In effect, most of the “contract” was never agreed to and is being defined/imputed by the courts after the fact.

Theory of Reliance

Many courts utilize the theory of “reliance” as justification for enforcing promises “to do” things and awarding damages for failure “to do” things. In theory, only “reasonable reliance” is considered valid. If someone is “unreasonable” in their reliance then it is not enforced. The problem with this approach is that it is circular reasoning. It is only reasonable to rely upon a promise if the courts are going to enforce it and courts should only enforce a promise if it is reasonable to rely upon it.

​​​​Concert Singer Contract

Imagine someone hired you for $200,000 dollars to sing at a concert. Once you were under contract, they marketed and sold tickets worth $1 million dollars. Now imagine on the day of the concert you get stage fright and opt not to sing. The concert organizer may be forced to refund $1 million dollars in tickets on top of all the expenses of reserving the venue and advertising. If you had sung, the concert organizer expected a profit of $200 thousand with expenses of $800 thousand, but since you didn’t sing the organizer had expenses of just $600 thousand but still had no revenue and failed to realize the anticipated profit. All told, the organizer was economically $800 thousand behind because of your failure to perform.

If taken to court, a judge might make you pay $600 to $800 thousand plus legal fees on the premise that your “failure to perform” caused damages. The question is whether it was reasonable to rely upon a promise to perform. Would you have agreed to sing if you knew the damages you would have to pay for failure to sing? Do you even have the ability to pay those damages? If the court ordered payment, could the organizer even collect it?

What we can learn from this example is that the courts can’t force you to sing and even if they could, they couldn’t force you to sing your best. Furthermore, if you fail to show up the hour before your performance, no court can hear the dispute in time to compel performance and prevent damages.

If it isn’t practical to compel performance, what is the alternative? Courts resolve most disputes by transferring title to property from the promise breaker to the other party. If the promise breaker doesn’t have property, then the courts authorize wage garnishment. In some cases courts give the promise breaker the option to perform or pay. This means that all contracts could be written such that there is no ambiguity regarding damages and everything is simply a pre-agreed conditional transfer of property.

The singer’s contract would read something like: if a song is performed then $200 thousand dollars owned by the organizer is transferred to the singer else $700 thousand dollars owned by the singer is transferred to the organizer. In the event of a dispute a judge or jury would only have to determine whether a song was performed as agreed. If the singer doesn’t have $700 thousand dollars, then the event organizer would need to find an insurer. If no insurer could be found, then the tickets would have to indicate that there is no refund if the singer is unable or unwilling to perform. The audience would end up crowd funding the “insurance”.

Smarter Contracts

Suppose it wasn’t possible to transfer the risk to insurers or customers and the singer didn’t have $700 thousand dollars. This poses an interesting question: can you contract to transfer title to something you don’t own? Imagine the contract read if a song is performed then the Brooklyn Bridge “owned” by the organizer is transferred to the singer else one billion tons of gold owned by the singer is transferred to the organizer. The organizer doesn’t own the Brooklyn Bridge and there isn’t anywhere near one billion tons of gold on the entire planet. Under my interpretation of the Title Transfer Theory of Contract, a contract is invalid if under any conditional outcomes a title transfer is indicated for which any party does not have current title. Anything else would be tantamount to a “to do” contract where the “doing” is acquiring title to the asset so that it could be transferred.

This interpretation of Title Transfer Theory of Contract has profound implications for almost every kind of contract. We are so used to viewing contracts as promises that it isn’t always intuitive to limit contracts to conditional title transfers. If you are not careful it is incredibly easy to fall back into a promise theory of contracts. Even Rothbard fell into this trap in a chapter titled, “Property Rights and the Theory of Contracts”, from his book The Ethics of Liberty.

Fortunately, there is a framework that ensures that it is impossible to construct an invalid contract: smart contracts. A smart contract is effectively computer code that deterministically executes an algorithm based upon the signed statements of individuals. Computer algorithms must be consistent and are unable to assign two owners to the same property at the same time. Anything that can be represented as a smart contract is compatible with the Title Transfer Theory of Contract. If it cannot be represented by computer code then it probably isn’t a valid, logically consistent, contract. The only thing the courts need to do to enforce smart contracts is to ensure that the physical property referenced by the smart contract is under the control of the owner specified by the smart contract. A smart contract need not be represented in software code in order to be smart. From this point forward I will refer to contracts compatible with the Title Transfer Theory of Contract as Smart Contracts.

Now let’s review how Rothbard fell back into the promise theory of contract. Rothbard’s mistake was in his example of a loan for $1000 dollars with a promise to repay $1100 dollars in a year. Let’s look at an excerpt from The Ethics of Liberty:

“Suppose that Smith and Jones make a contract, Smith giving $1000 to Jones at the present moment, in exchange for an IOU of Jones agreeing to pay Smith $1100 one year from now. This is a typical debt contract. What has happened is that Smith has transferred his title to ownership of $1000 at present in exchange for Jones agreeing now to transfer title to Smith of $1100 one year from now. Suppose that, when the appointed date arrives one year later, Jones refuses to pay. Why should this payment now be enforceable at libertarian law? Existing law largely contends that Jones must pay $1100 because he has “promised” to pay, and that this promise set up in Smith’s mind the “expectation” that he would receive the money.

Our contention here is that mere promises are not a transfer of property title; that while it may well be the moral thing to keep one’s promises, that is not and cannot be the function of law (i.e., legal violence) in a libertarian system to enforce morality. Our contention here is that Jones must pay Smith $1100 because he had already agreed to transfer title, and that the nonpayment means that Jones is a thief, that he has stolen the property of Smith. In short, Smith’s original transfer of the $1000 was not absolute, but conditional, conditional on Jones paying the $1100 in a year, and that, therefore, the failure to pay is an implicit theft of Smith’s rightful property.”

The mistake made by Rothbard is that a title cannot be transferred until the conditions are met; furthermore, Jones cannot agree to transfer title to $1100 dollars he does not have. If Jones wanted to spend the $1000 dollars he conditionally received from Smith, then the condition would be a lien that followed the $1000 dollars. If Jones used the $1000 dollars to buy a laptop from Alice he would have to disclose that he doesn’t have clean title to the $1000 dollars because he has not yet paid $1100 to Smith. Alice would have to accept the credit risk of Jones not paying Smith and would therefore make the transfer of title to the laptop contingent upon getting the lien on the money lifted. If Jones failed to pay $1100 dollars to Smith in one year, then Smith retains title to $1000 dollars and Alice retains title to the laptop. If Jones keeps the laptop he is a thief. If Alice keeps the $1000 dollars she is a thief. The $100 dollars of interest is an unenforceable promise that only exists as the condition upon which transfer of title to $1000 dollars may be effected. Titles held to money conditioned on different promises are not fungible. This means that there is no efficient way to use encumbered assets as money.

So how would lending work under a smart contract? Your contract with the bank will be something like: if required monthly payments are not made then title to the house is transferred to the bank. No promises are made, just predefined conditional transfers of assets to which the parties have clean title. Normally, recourse bank loans also hold you liable for the difference between what the bank can sell the house for and your loan balance. This arrangement would be invalid because all assets subject to the contract would have to be owned at the time the contract was entered in order to agree to transfer title to those assets. Since the borrower doesn’t have the money to pay cash for the house, she cannot sign a contract that transfers title to the cash. Any promise to pay cash would should be unenforceable because such a promise could not be implemented in computer code as smart contract. This means that only non-recourse collateralized loans are enforceable via smart contracts.

A smart contract on a blockchain is effectively an automated escrow agent which holds title to all assets subject to conditional transfers. Computer code governs how titles transfer based upon how the people involved in the contract interact. A smart contract could be implemented manually with a human escrow agent. A contract’s enforceability under a true democracy should be limited to the transfer of assets managed by the escrow agent. The parties to a contract need not hire a 3rd party escrow agent so long as they personally account for all liens on any property in their possession. In the event of a dispute a 3rd party can be brought in to interpret the smart contract and evaluate the conditions. Anyone who fails to transfer physical possession after such a ruling is no different than a thief.

Under the law of the jungle you could agree to transfer title to your body in the event you fail to follow through on your contractual terms. This would allow you to be thrown in prison, forced into a labor camp, or tortured until you comply. At the extreme you could contract to allow others to kill you. Since your body is practically indivisible, you would only be able to use it as collateral for one contract at a time. Imagine what would happen if you contracted to transfer title to your body in event of default in two different contracts with different people. One person wants to harvest your organs and the other wants to put you in a work camp. Once someone has a lien on your body it isn’t possible to sell your body to someone else or encumber it with additional liens. While such a contract might be possible, a community dedicated to protecting the independence of its members would be wise to not recognize and enforce such contracts.

Generally speaking, I would recommend that a community forbid enforcement of any loan with recourse beyond the collateral. This would include unsecured credit card debt. All contracts should be settled by title transfers for which it is impossible to put someone into bankruptcy. Bankruptcy is only possible to the extent contracts were written with respect to assets the parties did not have title to at the time the contract was agreed to. Credit cards could still exist, but the only recourse would be a note on someone’s credit rating. This may limit their ability to get future credit, but will not allow creditors to reclaim funds.

Multi-Dimensional Property Rights

Property can be conceived of in many dimensions. It has a location in three-dimensional space, but also in time. If you contract to lease a car next week you cannot double book the reservation because title in the use of the car at that time is no longer yours. Likewise, you cannot transfer title to money next month until you have title to that money next month. If a contract conceives of title transfers for assets that may not exist at the time of the transfer, then it should have a fallback. A promise to pay $1000 dollars next month is not binding unless you have title to it and encumber it with a lien. Property may have an infinite number of dimensions depending upon how you divide up “usage rights”. Time periods are simply one kind of usage right.

Nondisclosure Agreements

Let’s consider another kind of contract, a “nondisclosure agreement”. Such a contract would have to read: if information is disclosed then title to property is transferred. Would you sign a nondisclosure agreement that read: if information is disclosed then title to $1 million dollars is transferred? First of all, you would have to have $1 million dollars that is not encumbered by other contracts. Imagine that you only had $1 million dollars, and you signed a nondisclosure agreement with a 100 year term. Under a smart contract, you would have to lock that money up for 100 years and could not use it for anything that wasn’t subject to your ability to disclose information and cause transfer. If you wanted to sign a second nondisclosure agreement you would need to find other assets to secure it with. If you don’t secure a nondisclosure contract with title to assets you own, then it would be an unenforceable contract. In this case, the cost of breaching the nondisclosure contact is only your reputation (e.g. credit rating). In practice, nondisclosure contracts should be restructured as “fee for disclosure” or have short windows of time during which assets are encumbered.

What about “noncompete” clauses? Like nondisclosure, it is a meaningless promise only enforceable by reputation damage unless you encumber the title to other assets on condition that you do not compete. An employee with no assets would have very little with which to back a noncompete agreement; however, a large company could back the agreement with equity.

Community peace treaties that aim to implement a true democracy should recognize property rights and smart contracts with respect to property title. Furthermore, promises “to do” things should not be enforced as such, but instead property titles should be transferred subject to pre-agreed “objective” conditions. It is not reasonable to know how other people are relying upon your promises and what damages they might claim; therefore, it is not possible to consent to open-ended damages. Without consent a contract is not valid nor is the “democracy in name only” that attempts to enforce it.

One of the greatest innovations of the blockchain industry is the concept of smart contracts. When implemented on a blockchain, a smart contract is a “self-executing”, deterministic agreement among parties enforced by a community without reliance on a credible threat of violence. Traditionally smart contracts are used with respect to purely digital property because the blockchain has complete authority over its database. Representing all property rights under a “software is law” mindset provides a useful framework for constructing smart contracts enforced by more manual means. In principle, all agreements should be capable of representation in software which manages the transfer of title of any and all property based upon relatively objective conditions. Any contract that could not be translated into equivalent code should be considered invalid.

The Value of Trust

Organizing higher-order communities on top of the law of the jungle depends upon trust. Without trust, contracts become much more expensive to document and enforce. In low trust environments many transactions are not even possible because the cost of creating a contract is greater than the value of the transaction. Reputation is the basis of trust and failure to keep promises will damage reputation and increase everyone’s cost of doing business.

Contract law should largely be re served for high-value transactions and everything else should be unenforceable in the courts. At most a court or private arbitration system could render an opinion that you broke a promise. That opinion, being public record, would, in turn, impact all your other business dealings. This should be incentive enough to keep your word without getting into subjective damages.

One of the benefits of organizing society according to the Rules of Relative Power (Chapter 4) and Encapsulation (Chapter 5) is that it is easier to build trust in small communities and that can make these communities more efficient in many ways. Trust is a function of Dunbar’s research into the number of relationships our brains can maintain. Trust is largely based upon knowing people and there are only so many people whom you can know well enough to directly trust. When you heavily rely upon indirect means of trusting people you risk transferring and concentrating power in ways that can undermine true democracy.

In societies where 99% of the people you meet can be “trusted by default” things prosper. In societies where you can only trust your friends and family things stagnate. Extensive reliance on a community peace treaty to enforce promises in contracts is already a sign that trust is decaying. In an ideal world, reputation would be highly valued and therefore trust is so high that written promises are only required to remind the parties of the agreement. In such a society everyone takes the non-recourse risk that the other party will default. Loans are made without liens being filed at the courthouse. Doors are left unlocked and children play in the streets.

We should not attempt to replace trust with contracts nor enforce promises by courts assessing subjective damages. Ambiguous evaluation of contracts breaks down trust in the peace treaty (government) itself and yields too much subjective and undemocratic power to the courts. That said, smart contracts and community courts are a necessary background upon which trust can be built. The more predictable court rulings become the less time people spend fighting in court and the more quickly people settle things among themselves. Predictable court rulings require a philosophy of contract that is equally predictable. It is for this reason that I believe everyone (or at least every lawyer) should strive for a deep understanding of the Title Transfer Theory of Contract so that they can write smarter contracts.

Most Contracts are Unenforceable

We already live in a society where 99% of contracts are unenforceable. Lawyers cost hundreds of dollars per hour. Navigating the system without lawyers is error prone and takes months of study. Even if you win in small claims court, 80% of the judgments are never paid. The inability to pay a judgment is another failure of the promise theory of contract. Judgments on smart contracts are either payable or the other party is subject to criminal theft. I will go into more detail on criminal justice in the next chapter.

Once you move beyond small claims court, the legal fees start mounting quickly. I was in a business dispute and was given an estimate of $100K in legal fees to enforce a case I felt was open and shut, and that was just my side of the expenses. Despite the obvious facts, the lawyers couldn’t give me any reasonable guarantees of winning. Fortunately we came to a settlement, but only after incurring thousands of dollars in legal fees. Many times in divorces, the cost of fighting over the assets is greater than the total value of all assets of the marriage. In most cases, it makes more sense to suffer a loss than to pursue enforcement of contracts. Once you realize this, you realize that we are already living in a world where the vast majority of contracts are unenforceable.

Avoiding Imputed and Implied Contracts

Sadly, one of the biggest reason for entering a contract today is to attempt to avoid the courts imputing an implied contract in its place. Most contracts spend a ton of ink making it explicit that nothing was promised, represented, or owed. Still more ink is spilled making sure the customer takes personal responsibility for any and all risks associated with the transaction. In effect, contracts have become about all of the potential, unreasonable, and unexpected liabilities that could be implied by courts simply by interacting with other people. It is so bad that you cannot even “give software away” for anyone to use without 50% of the “free software license” being about limiting liability.

Here is the BSD license:

THIS SOFTWARE IS PROVIDED BY <COPYRIGHT HOLDER> ‘‘AS IS’’ AND ANY EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE ARE DISCLAIMED. IN NO EVENT SHALL <COPY- RIGHT HOLDER> BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, EXEMPLARY, OR CONSEQUENTIAL DAMAGES (INCLUDING, BUT NOT LIMITED TO, PROCUREMENT OF SUBSTITUTE GOODS OR SERVICES; LOSS OF USE,DATA, OR PROFITS; OR BUSINESS INTERRUPTION) HOWEVER CAUSED AND ON ANY THEORY OF LIABILITY, WHETHER IN CONTRACT, STRICT LIABILITY, OR TORT (INCLUDING NEGLIGENCE OR OTHERWISE) ARISING IN ANY WAY OUT OF THE USE OF THIS SOFTWARE, EVEN IF ADVISED OF THE POSSIBILITY OF SUCH DAMAGE.

Not only does this disclaimer account for 50% of the license text, but it is also in all capital letters. The MIT license also spends about 50% of its text on the same kind of boiler plate.

Under a smart contract all potential liabilities and conditions are explicit. Contracts only get drafted for big ticket items and are completely unnecessary at all other times. We eliminate a large percentage of “economically pointless” contracts when everyone knows that a “verbal contract” is not enforceable and that the courts cannot create “implied contracts”. A society based upon smart contracts completely eliminates the vast majority of the “contracts” you sign and the smart contracts that remain are vastly simplified.

This simplification of contracts empowers people and disempowers courts. This makes everyone more equal and therefore is a critical component of true democracies. In a subsequent chapter on Financial Integrity it will become clear how smart contracts prevent most forms of “legalized” financial fraud. The next chapter deals with how justice can be had when you are harmed by someone with whom you had no contract.

Is the Peace Treaty a Promise or a Smart Contract?

Smart contracts are built upon an assumption of a preexisting agreement over property rights. Rothbard proposes we agree that the first person to homestead gets assigned the property rights. I propose that property belongs to whoever can control it. That control is subject to physical strength and social strength. Two people can agree to recognize property rights, but this agreement isn’t a contract, it’s a mutual promise built on trust and reputation. The promise is only enforceable by the natural “jungle strength” of the parties.

It is theoretically possible for a peace treaty to define property rights and contract law by the reliance theory, by the damages theory, or by any other theory of contract. At the end of the day, all that matters is that trust is maintained and people continue to agree to live in peace rather than war.

Ultimately this means that all contracts are based upon the enforcement of the promise made in the peace treaty. We use jungle power to enforce the promises made to reach peace. So why limit ourselves to smart contracts (conditional title transfers) in the peace treaty? Because the peace treaty must be clear, simple, and sustainable. It must be designed to avoid conflict and moral hazard. It must be designed to prevent abuse under the color of law. Any peace treaty that fails in this regard will not last. All other theories of contract have logical inconsistencies evidenced by the inability to represent themselves as computer code and enforce themselves as a smart contract. These logical inconsistencies lead to conflict and ultimately to failure of the peace treaty. Conflict transfers power to judges which ultimately undermines true democracy as the judges become the arbiters of who owns what instead of the people.

Not everything is equally life sustaining. Not all peace treaties are advisable. The purpose of this book is to provide council to those faced with negotiating a peace treaty under the assumption that all parties have equal jungle power. It is an attempt to present an agreement agreeable to all parties and biased toward none. Smart contracts are the only logically consistent view of property rights I have come across.

How has our current system been working for you? If you have never been to court then you probably have never actually relied on the enforceability of a contract nor experienced the insanity created by the current system. We can do better and I promise you it is worth your time to fully internalize the principles and the power of smart contracts.

Yeah, But, What about…

I have presented the smart contract approach to contracting to many people and have gotten a lot of feedback. We are so used to viewing contracts as promises that we cannot imagine a world that relied only on smart contracts or reputation. Things appear to be working “as is” so why should a book about true democracy advocate such a fundamental change to every business arrangement? Can’t we keep a promise theory of contract and still adopt the other principles of true democracy?

To make contractual promises enforceable (beyond a posted bond), is to imbue them with the characteristics of property. My promise to pay you $1 trillion dollars becomes an asset on your books because, “by law”, if I fail to pay, the government is supposed to make me pay. Everyone should know that I don’t have $1 trillion dollars nor ability to earn it and that there is nothing the government can do to enforce this contract. The damages one seeks from broken promises must come from somewhere. If there are no assets to back the promise then the promise has potentially no value. Any accountant worth their salt knows better than to count their chickens (promises) before they hatch.

If a promise to pay $1 trillion dollars I don’t have is obviously not a valid “contract” then at what point does a promise become valid and therefore enforceable? $1 billion dollars? $1 million dollars? $1 thousand dollars? $1 dollar? The fact that promises should not be considered enforceable should be obvious for anyone doing business with the poor. No matter what contract a poor person signs, if they don’t keep their promise, there is nothing you can do to collect damages. You can’t get blood out of a turnip.

The consequence of enforcing promises, as opposed to conditional title transfers, is to encourage people to build their economic house on a foundation of sand. It enables fraud by transmuting something that should have no value into something that is presumed to have value. An insurance company makes promises to provide a level of coverage that they mathematically cannot keep in certain circumstances. Those relying upon that promise will be disappointed when their insurance company goes bankrupt when they need it most because they misestimated the frequency and magnitude of potential claims.

Manufacturers make promises to provide a warranty. We assume these promises are worth something because people perceive companies to be “big” and “rich” compared their customers. The problem is that in order for a company to make good on its promises it must set aside capital to “self insure” against defects. This capital must come from the customers in the form of increased prices. Because the manufacturer cannot possibly know the magnitude of potential claims nor the liability, they will either end up overcharging or over promising and neither the customer nor the manufacturer knows the reality until the end of the warranty period. From this perspective, a lifetime warranty is an unbacked and therefore potentially unenforceable promise. A company promising a lifetime warranty is selling you a bill of goods unless they are setting aside segregated funds to back the warranty. Due to fierce market competition and price conscious customers, companies often find it cheaper to provide unbacked warranty promises and hope for the best. Try collecting on a lifetime warranty from a bankrupt manufacturer!

Banks make promises to pay on demand, but if everyone attempted to collect on that promise at the same time the bank would be insolvent. How is this a valid contract? How can the governments enforce such a contract? They can’t and they don’t.

Imagine you signed 1000 contracts for various things. In each contract you have the ability to pay the potential damages but only if you don’t default on any of the other 999 contracts. How is this different than fractional reserve banking? Are your counter-parties aware of the risk that you may not be able to pay damages if you fail to keep your contractual promises?

Even under the “promise theory of contracts”, a contract must have the consent of the parties to be considered valid. In order to consent one must have knowledge. How can one have knowledge of the extent to which failure to perform a promise will “harm” the other party if you must wait for a judge to “assess” damages after the fact? If you do not know the limits on your liability then how can you consent? If you lack the ability to pay the damages as outlined in the contract or awarded by a judge, then how is a government to enforce it? The supposed “contract” is invalid to both sides, one side is unable to consent while the other side is unable to collect.

A true democracy should facilitate people working together and building trust. The consequence of defaulting on promises is a loss of trust. We must all take personal responsibility in determining who to trust and bearing the cost of misplacing our trust. If we allow promise based contracts to be enforced with the full “jungle power” of the community then we introduce moral hazard at the most fundamental level. We allow one person to take the risk of trusting someone and expect everyone else to bear the cost of enforcing the collection of damages when that trust was misplaced. The consequence of this is to cause members of society to grant trust to people who do not deserve it. This is because people aren’t trusting each other, they are trusting the illusion of an enforceable contract.

Never do business with someone you do not trust. If trust is lacking, then a smart contract is how a community should document an enforceable contract. If a contractual promise is broken, then your only recourse should be to warn others about the breach.