Digitalisation facilitates transactions of increasingly smaller scale - with slivers of transactions of short duration, for stakes which are close to token or for sub-elements of property rights. However, it is challenging to create legally enforceable trading frameworks for micro-transactions because even very small frictions overwhelm the value of the transaction. Lawyers have endeavoured to transform contracts with plain English drafting, online standard contracts and smart contracts, but this is more a case of old wine in new digital bottles.
In the Harvard Journal of Law and Technology , the US legal academic Yonathan Arbel canvasses how a new model, called nano contracts, could downsize the contracting process to better fit micro-transactions.
Arbel illustrates new monetisation opportunities which nano contracts could open up:
In a world of self-driving cars, drivers before leaving home enter their destination and their level of urgency, allowing the app to determine how much they value priority. As drivers approach an intersection, a silent auction is held, with drivers bidding in increments of pennies or in tokens for the right to pass through the intersection. The driver who wins the auction receives the right of way, and the apps seamlessly exchange payments between them in the background. Brandon, who left late for his meeting with a wedding photographer but paid his way to arrive on time, is now $3.10 poorer, but much happier. Nicole, who had a relaxing afternoon ahead of her, leisurely parks her car at her friend’s house after collecting $4.30 in fees along the way and brings her friend a cup of coffee.
While Arbel acknowledges this may look like ‘legal sci-fi’, there are a growing number of examples of slivers of transactions:
You can speculate in oil futures in a single lot of 10 barrels over a 3 month duration.
Nano options are described as “a darling in the investment world”. Traditional options have a multiplier of 100, meaning a single options contract controls 100 shares of stock, often across a range of companies. Nanos have a multiplier of 1 instead of 100 and have a maximum settlement of 1 week.
What is a nano contract?
Nano contracts have been defined as follows:
Arbel goes one step further on miniaturisation:
The question is how nano contracts might differ from other forms of digital contract. The answer, which admittedly sounds like it comes from a college application, is focus and ambition. Unlike smart contracts, which are primarily tools of contract governance, nano contracts’ focus and ambition is to solve the problem of contract formation.
The two key characteristics of nano contracts are that they are “digitally negotiated agreements that employ automated and near-instantaneous bargaining processes in multiparty peer-to-peer (p2p) transactions” and “what makes them nano is their scale, they last a few seconds; transfer cents, milles, and even smaller fractions of the dollar; or transfer slivers and fragments of the bundle of rights of ownership”.
The technology trends driving micro-transactions
Like many digital trends, micro-transactions appear to have originated in the gaming world: for example, gamers purchasing keys to loot boxes which, when opened, provide in-game rewards on a chance basis.
Arbel says the growing trend for micro-transactions beyond the gaming world is driven by two factors:
The Cloud (or everythingaaS): the migration of services, content and distribution into the cloud - and the monetisation model of renting access which the cloud enables - produces “a growing trend to disaggregate product bundles to the specific functions that the end user cares about”, itself described as a “nanonization of products and services”.
The gig economy: the Internet made it possible to build large-scale marketplaces for small transactions, showing that “once transaction costs are tamed, many people are happy to let strangers use their private homes, drive their cars, share their parking space, and even provide excess storage room in their closet”.
By enabling parties to “create contracts at vanishingly low cost and near-zero latency”, nano contracts will accelerate these two trends to drive transactions of ever smaller scale.
What might we micro-transact?
Arbel identifies a range of potential new monetisation opportunities which nano contracts could open up:
Market for time: queuing (physical or virtual) is one of the banes of modern existence. Arbel proposes:
Nano contracts... offer a solution to the problem of queues by creating a protocol for parties to directly, quickly, and potentially anonymously, negotiate the allocation of places in the line among themselves. A nano contract can just as easily be used to auction off a place in line at airport security, at a baseball stadium, and at the pharmacy. It can also be used to pay email recipients to afford special attention to one’s email, transmit data faster on the Internet, or get priority for technical support.
Monetising queuing could be seen undermining the “democratic ethos [of queues] which visibly affirms our equality as we all languish in waiting, regardless of wealth, race, or creed”. However, Arbel responds that the rich already have special access (VIP entrances) or pay large amounts to line waiters and, even without that queue bypassing, queuing rules work against the disadvantaged:
The current system is not inherently beneficial to the economically disadvantaged, and one’s place in line is a matter of institutional familiarity, advanced planning, the capacity and flexibility to execute on those plans, and, of course, luck. Nano contracts mitigate these factors, which often favour those who are well off.
Arbel acknowledges there needs to be some limits to the market for time:
Prominent examples where notions of queue ethic may be applicable include the line to the voting booth, kidney transplants, a place in line for the draft or jury duty, fresh water during a natural disaster, waiting for a court to render a judgment, or access to medical resources during a pandemic. In those cases it will certainly be true that commoditizing the line would undermine this goal. Explicit markets in lines in such instances may be offensive to our sense of equality and justice by expressing the view that some people’s rights, votes, lives, or sufferings are more valuable than those of others. By creating markets in those domains, we risk changing the very nature of the good itself.
Nano gigs: already apps such as Air Tasker support trading in labour for one-off tasks, 36% of the US workforce engages in the gig economy. Arbel says nano contracts could enable more instantaneous engagement for even smaller tasks, such as person with a flat tyre advertising to passing cars on a highway for someone to assist in changing the tyre or “[j]ust think of the users of public transportation and how they can leverage the long, circuitous rides if they could access nano jobs on their commute”.
Nano leases: Arbel observes that “[m]ost of our personal resources are underutilized”. Hence AirBnB-ing your spare room, or even renting out your spare couch . Nano contracts, by lowering transaction costs, would allow spare capacity of even smaller items to be leased out, such as individual clothing items or down minutes of internet time .
Nano accidents: in his most creative forecasting of future applications, Arbel argues the nano contract could be a substitute for the law of torts. Back in 1960, a leading UK economist, Robert Coarse, argued that under ideal economic conditions, where there is a conflict of property rights, the most efficient outcome is for the involved parties to negotiate terms that will accurately reflect the full costs and underlying values of the property rights at issue. But Coarse also acknowledged that, in the real world, we need the law of torts because the transaction costs are too high for the injuring party and the injured party to resolve responsibility between themselves and so the law of torts must decide the outcome of accidents. Arbel argues that if nano contracts substantially lowers the transactions costs, Coase’s primary rule springs back into life, and he gives the following example:
A train is speeding down the tracks in Iowa. Suddenly, the train’s computer reports an imminent electrical load. To avoid damaging the engine, the operator must quickly decide where to emit the sparks: to the right, where there is a corn field; or to the left, where there is a soybean field Now suppose the market rates for soybean and corn are $1,118 and $758 respectively Using a real-time lowest price auction, the conductor can negotiate the accident with the farmers. Neither farmer wants the sparks to cause harm to their crops, but the corn farmer knows that the expected harm to their field is $1,118. Therefore, they bid $5,000 to protect their profits.
This allows the corn farmer to come out ahead in the event of an accident. The soybean farmer also sees an opportunity to protect their profits. Since the expected harm to their field is only $754, they can outbid the corn farmer and ask for only $4,000. Even at this reduced rate, the soybean farmer will come out ahead from the accident. Since they will still profit even if they bid $3,000, they will underbid accordingly. Through this split-second auction process, it is expected that the soybean farmer will win with a bid of $1,117. This will cause the conductor to emit sparks onto the soybean field, causing harm of $754. The soybean farmer comes out $363 ahead, and the more valuable crop is saved.
Hurdles to nano contracts
To form a contract, the contracting parties must solve the triangulation costs, being the combined costs of locating potential service providers, settling on their price, and agreeing on terms. Nano contracts do so at close to zero cost by relying on advance consent and automated negotiations, so that the apps of the contracting parties can execute the contract between them: in the self driving example at the outset, Duncan and Nicole set their auction prices for rights of way before they begin their journeys.
However, Arbel acknowledges that other necessary elements for an effective, enforceable framework for nano contracts are trickier, but familiar in the existing gig economy:
Payment: Arbel observes that “[i]t is surprisingly expensive to transfer payments because traditional payment systems were designed for large, not small, transactions.” The gig economy has addressed payment issues through a number of mechanisms: reputation, failure to pay will ‘blot a person’s copybook’ for future transactions on the same platform; and the platform provider, which often has deep pockets, may float the payment or cover failed payments.
Enforcement: resorting to courts for orders of specific performance is too expensive and slow even for contracts of fairly large scale. Again the experience in the gig economy is that reputation (your rating as a buyer or seller) is a strong incentive to ensure both parties comply with the deal.
Dispute resolution: Arbel makes the point that “[p]erhaps the most sensitive part of small-stake contracts is dispute resolution, if disputes are never settled, parties can breach with impunity, undermining the entire system.” While policymakers and courts have put considerable effort into designing and making available low-cost dispute resolution processes even these are likely to be too ‘outsized’ for micro-transactions. Arbel says that the gig economy experience shows that the platforms have strong incentives to quickly resolve disputes to protect the integrity of the service by quickly refunding customers out of their own pocket or offering their own corporate courthouses to resolve more substantive or difficult disputes.
Arbel acknowledges, while he identified the decentralised, flexibility of multiple P2P dealings as a defining feature of nano contracts, solving these issues relies on platform providers and may reinforce platform power. We are already seeing platform providers offering nano contracts, such as Hathor .
Conclusion
Arbel cautions that he is not predicting the end of contracting as we know it. But market and technology trends mean, as Arbel puts it, “transactions want to be small” and we need to consider the impacts on our traditional contracting mechanisms.
There are also some bigger issues here. Although Arbel dismisses as romantic the view that queuing has a democratic ethos, there is something disturbing in a contracting mechanism that is so frictionless that it allows monetisation of individual behaviour otherwise determined by social norms or legal rules.
Read more: On the scales of private law: nano contracts
Peter Waters
Consultant