The Batman Fallacy, Smart Contracts, and Cryptosecurities

I’ve noticed that people that talk about cryptosecurities and the blockchain have made a basic mistake that I call the Batman fallacy.

There is a scene in the Dark Night Rises in which Bane attacks the Gotham Stock Exchange and uses the stolen fingerprints of Bruce Wayne to gain control of Wayne Enterprises.  It’s a cool scene.  The problem is that stocks don’t work this way, and the fact that stocks don’t work this way causes problems for blockchain applications.

We need to make a distinction between possession and ownership.  I have five dollars in my wallet and it gets stolen by a pickpocket.  I no longer have possession of that five dollars, but I still am the ownership of the money.  With cash, there is a very strong linkage between possession and ownership.  When I give my dollars to buy coffee and doughnuts, possession and ownership are transferred.  The law involving cash encourages there to be a strong link between possession and ownership.  In particular, suppose a thief steals my cash, and then uses it to buy coffee.  At that point the person that sold the thief coffee now has both possession and ownership of my money, and I can’t get my cash from the coffee house.  The thief still owes me money, but I can’t get it from anyone they transferred the money to.

Not here that money is special.  If the thief stole my watch, and used it to barter for coffee, I could still get possession from whoever holds the watch.  This is why cash is special.  You can ask what happens if the thief transfers money by using check.  It turns out that checks are also special in most places.

But the point here is that with cash, possession and ownership are pretty close to the same thing.  This is why bitcoin works.

Now you run into a problem if you use the bitcoin model with securities, because there is no such thing as possessing a share of stock.  The stock for Wayne Enterprises registered under Bruce Wayne or his agents.  It doesn’t matter what you do as long as you don’t follow the legal process of transferring ownership, the stock is owed by Bruce Wayne.  The concept of “possessing” stock the way that you possess cash just doesn’t exist.  This is intentional, and it was intended to prevent the type of thing that Bane tried to do with the Gotham Stock Exchange.

Because stocks cannot be “possessed”, this makes it harder to put them onto a blockchain.  This is also an issue with contracts.  One reason that no one has bothered putting contracts onto a blockchain is that it doesn’t matter.  One thing about stocks and bonds is that there is a pretty interesting system for tracking ownership of securities.  What happens is that most stocks and bonds are registered in the name of a broker, and the broker maintains a record of who owns what shares.  One reason for this is that it takes a surprising long time (i.e. two to three days) to transfer registration of a security, and so people have come up with this system to give you the illusion that ownership is being transferred instantly.

I should point out that the fact that brokers are critical for keeping track of who owns what stock is why you can’t easily get rid of them.

There are three ways that I can think of that can get around this issue:

1) You can put the stock into a trust, and then name as the beneficiary of the trust, whoever holds the token X.

2) You can create an options or futures contract or use warrants.  One thing about options, futures, and warrants is that they are designed to be tradeable more or less like cash.  So a company could rather easily issue crypto-warrants or crypto-futures and have them redeemable for shares.

3) Also if you are a techie, you could come up another more crypto based solution.  The idea would be to allow anyone to record a transfer of ownership on the ledger, but to have some mechanism by which you could quickly annotate and filter which transfers are “valid.”  For example, in our Gotham scenario, Bane would record a transfer of Wayne Enterprises on the ledger to the bad people, but then Bruce Wayne or his lawyers would then annotate the blockchain to object to the transfer.  Everything would be recorded on the blockchain at which point you’d have some sort of tool to figure things out.

There might be others, but there is a point that needs to be made.  Something that people don’t quite realize is how complex things are.  You don’t realize the complexity because most of the time “things just work.”  You had the cashier at a coffee house money and get your coffee and you don’t realize that there are some really complicated legal things going on here.  The other thing is that a lot of the complexity is evolved rather than designed.  People use stocks for something different than cash and so the system has evolved around that.