Smart contracts vs incomplete contracts: A transaction cost economics viewpoint

Abstract

For the deterministic nature of the blockchain, smart contracts (agreements enforced by a blockchain) are supposed to work at lower transaction costs than traditional, incomplete contracts (which instead exploit a costly legal enforcement). This paper challenges that claim. I argue that because of the need for adaptation to mutable and unpredictable occurrences (a chief challenge of transaction cost economics), smart contracts may incur higher transaction costs than traditional contracts. This paper focuses on two problems related to adaptation: first, smart contracts are constructed to limit and potentially avoid any ex-post legal intervention, including efficiency-enhancing adaptation by courts—this may increase transaction costs in smart contracts. Second, the consensus mechanism on which every smart contract depends may lead to additional transaction costs due to an uncertain, majority-driven change of the blockchain that follows Mancur Olson’s Logic of groups. The paper further proposes several institutional expedients that may reduce these transaction costs of smart contracts.