Assassination Politics

[grarpamp]

> the promise of smart contracts for beneficial goals.

An Introduction to Futarchy
Vitalik Buterin
Research & Development

https://blog.ethereum.org/2014/08/21/introduction-futarchy/

One of the more interesting long-term practical benefits of the
technology and concept behind decentralized autonomous organizations
is that DAOs allow us to very quickly prototype and experiment with an
aspect of our social interactions that is so far arguably falling
behind our rapid advancements in information and social technology
elsewhere: organizational governance. Although our modern
communications technology is drastically augmenting individuals’
naturally limited ability to both interact and gather and process
information, the governance processes we have today are still
dependent on what may now be seen as centralized crutches and
arbitrary distinctions such as “member”, “employee”, “customer” and
“investor” - features that were arguably originally necessary because
of the inherent difficulties of managing large numbers of people up to
this point, but perhaps no longer. Now, it may be possible to create
systems that are more fluid and generalized that take advantage of the
full power law curve of people’s ability and desire to contribute.
There are a number of new governance models that try to take advantage
of our new tools to improve transparency and efficiency, including
liquid democracy and holacracy; the one that I will discuss and
dissect today is futarchy.

The idea behind futarchy was originally proposed by economist Robin
Hanson as a futuristic form of government, following the slogan: vote
values, but bet beliefs. Under this system, individuals would vote not
on whether or not to implement particular policies, but rather on a
metric to determine how well their country (or charity or company) is
doing, and then prediction markets would be used to pick the policies
that best optimize the metric. Given a proposal to approve or reject,
two prediction markets would be created each containing one asset, one
market corresponding to acceptance of the measure and one to
rejection. If the proposal is accepted, then all trades on the
rejection market would be reverted, but on the acceptance market after
some time everyone would be paid some amount per token based on the
futarchy’s chosen success metric, and vice versa if the proposal is
rejected. The market is allowed to run for some time, and then at the
end the policy with the higher average token price is chosen.

Our interest in futarchy, as explained above, is in a slightly
different form and use case of futarchy, governing decentralized
autonomous organizations and cryptographic protocols; however, I am
presenting the use of futarchy in a national government first because
it is a more familiar context. So to see how futarchy works, let’s go
through an example.

Suppose that the success metric chosen is GDP in trillions of dollars,
with a time delay of ten years, and there exists a proposed policy:
“bail out the banks”. Two assets are released, each of which promises
to pay $1 per token per trillion dollars of GDP after ten years. The
markets might be allowed to run for two weeks, during which the “yes”
token fetches an average price of $24.94 (meaning that the market
thinks that the GDP after ten years will be $24.94 trillion) and the
“no” token fetches an average price of $26.20. The banks are not
bailed out. All trades on the “yes” market are reverted, and after ten
years everyone holding the asset on the “no” market gets $26.20
apiece.

Typically, the assets in a futarchy are zero-supply assets, similar to
Ripple IOUs or BitAssets. This means that the only way the tokens can
be created is through a derivatives market; individuals can place
orders to buy or sell tokens, and if two orders match the tokens are
transferred from the buyer to the seller in exchange for USD. It’s
possible to sell tokens even if you do not have them; the only
requirement in that case is that the seller must put down some amount
of collateral to cover the eventual negative reward. An important
consequence of the zero-supply property is that because the positive
and negative quantities, and therefore rewards cancel each other out,
barring communication and consensus costs the market is actually free
to operate.
The Argument For

Futarchy has become a controversial subject since the idea was
originally proposed. The theoretical benefits are numerous. First of
all, futarchy fixes the “voter apathy” and “rational irrationality”
problem in democracy, where individuals do not have enough incentive
to even learn about potentially harmful policies because the
probability that their vote will have an effect is insignificant
(estimated at 1 in 10 million for a US government national election);
in futarchy, if you have or obtain information that others do not
have, you can personally substantially profit from it, and if you are
wrong you lose money. Essentially, you are literally putting your
money where your mouth is.

Second, over time the market has an evolutionary pressure to get
better; the individuals who are bad at predicting the outcome of
policies will lose money, and so their influence on the market will
decrease, whereas the individuals who are good at predicting the
outcome of policies will see their money and influence on the market
increase. Note that this is essentially the exact same mechanic
through which economists argue that traditional capitalism works at
optimizing the production of private goods, except in this case it
also applies to common and public goods.

Third, one could argue that futarchy reduces potentially irrational
social influences to the governance process. It is a well-known fact
that, at least in the 20th century, the taller presidential candidate
has been much more likely to win the election (interestingly, the
opposite bias existed pre-1920; a possible hypothesis is that the
switchover was caused by the contemporaneous rise of television), and
there is the well-known story about voters picking George Bush because
he was the president “they would rather have a beer with”. In
futarchy, the participatory governance process will perhaps encourage
focusing more purely on proposals rather than personalities, and the
primary activity is the most introverted and unsocial affair
imaginable: poring over models, statistical analyses and trading
charts.

A market you would rather have a beer with

The system also elegantly combines public participation and
professional analysis. Many people decry democracy as a descent to
mediocrity and demagoguery, and prefer decisions to be made by skilled
technocratic experts. Futarchy, if it works, allows individual experts
and even entire analysis firms to make individual investigations and
analyses, incorporate their findings into the decision by buying and
selling on the market, and make a profit from the differential in
information between themselves and the public - sort of like an
information-theoretic hydroelectric dam or osmosis-based power plant.
But unlike more rigidly organized and bureaucratic technocracies with
a sharp distinction between member and non-member, futarchies allow
anyone to participate, set up their own analysis firm, and if their
analyses are successful eventually rise to the top - exactly the kind
of generalization and fluidity we are looking for.
The Argument Against

The opposition to futarchy is most well-summarized in two posts, one
by Mencius Moldbug and the other by Paul Hewitt. Both posts are long,
taking up thousands of words, but the general categories of opposition
can be summarized as follows:

    A single powerful entity or coalition wishing to see a particular
result can continue buying "yes" tokens on the market and
short-selling "no" tokens in order to push the token prices in its
favor.
    Markets in general are known to be volatile, and this happens to a
large extent because markets are "self-referential" - ie. they consist
largely of people buying because they see others buying, and so they
are not good aggregators of actual information. This effect is
particularly dangerous because it can be exploited by market
manipulation.
    The estimated effect of a single policy on a global metric is much
smaller than the "noise" of uncertainty in what the value of the
metric is going to be regardless of the policy being implemented,
especially in the long term. This means that the prediction market's
results may prove to be wildly uncorrellated to the actual delta that
the individual policies will end up having.
    Human values are complex, and it is hard to compress them into one
numerical metric; in fact, there may be just as many disagreements
about what the metric should be as there are disagreements about
policy now. Additionally, a malicious entity that in current democracy
would try to lobby through a harmful policy might instead be able to
cheat the futarchy by lobbying in an addition to the metric that is
known to very highly correllate with the policy.
    A prediction market is zero-sum; hence, because participation has
guaranteed nonzero communication costs, it is irrational to
participate. Thus, participation will end up quite low, so there will
not be enough market depth to allow experts and analysis firms to
sufficiently profit from the process of gathering information.

On the first argument, this video debate between Robin Hanson and
Mencius Moldbug, with David Friedman (Milton’s son) later chiming in,
is perhaps the best resource. The argument made by Hanson and Friedman
is that the presence of an organization doing such a thing
successfully would lead to a market where the prices for the “yes” and
“no” tokens do not actually reflect the market’s best knowledge,
presenting a massive profit-earning opportunity for people to put
themselves on the opposite side of the attempted manipulation and
thereby move the price back closer to the correct equilibrium. In
order to give time for this to happen, the price used in determining
which policy to take is taken as an average over some period of time,
not at one instant. As long as the market power of people willing to
earn a profit by counteracting manipulation exceeds the market power
of the manipulator, the honest participants will win and extract a
large quantity of funds from the manipulator in the process.
Essentially, for Hanson and Friedman, sabotaging a futarchy requires a
51% attack.

The most common rebuttal to this argument, made more eloquently by
Hewitt, is the “self-referential” property of markets mentioned above.
If the price for “trillions of US GDP in ten years if we bail out the
banks” starts off $24.94, and the price for “trillions of US GDP in
ten years if we don’t bail out the banks” starts off $26.20, but then
one day the two cross over to $27.3 for yes and $25.1 for no, would
people actually know that the values are off and start making trades
to compensate, or would they simply take the new prices as an
indicator of what the market thinks and accept or even reinforce them,
as is often theorized to happen in speculative bubbles?
Self-reference

There is actually one reason to be optimistic here. Traditional
markets may perhaps be often self-referential, and cryptocurrency
markets especially so because they have no intrinsic value (ie. the
only source of their value is their value), but the self-reference
happens in part for a different reason than simply investors following
each other like lemmings. The mechanism is as follows. Suppose that a
company is interested in raising funds through share issuance, and
currently has a million shares valued at $400, so a market cap of $400
million; it is willing to dilute its holders with a 10% expansion.
Thus, it can raise $40 million. The market cap of the company is
supposed to target the total amount of dividends that the company will
ever pay out, with future dividends appropriately discounted by some
interest rate; hence, if the price is stable, it means that the market
expects the company to eventually release the equivalent of $400
million in total dividends in present value.

Now, suppose the company’s share price doubles for some reason. The
company can now raise $80 million, allowing it to do twice as much.
Usually, capital expenditure has diminishing returns, but not always;
it may happen that with the extra $40 million capital the company will
be able to earn twice as much profit, so the new share price will be
perfectly justified - even though the cause of the jump from $400 to
$800 may have been manipulation or random noise. Bitcoin has this
effect in an especially pronounced way; when the price goes up, all
Bitcoin users get richer, allowing them to build more businesses,
justifying the higher price level. The lack of intrinsic value for
Bitcoin means that the self-referential effect is the only effect
having influence on the price.

Prediction markets do not have this property at all. Aside from the
prediction market itself, there is no plausible mechanism by which the
price of the “yes” token on a prediction market will have any impact
on the GDP of the US in ten years. Hence, the only effect by which
self-reference can happen is the “everyone follows everyone else’s
judgement” effect. However, the extent of this effect is debatable;
perhaps because of the very recognition that the effect exists, there
is now an established culture of smart contrarianism in investment,
and politics is certainly an area where people are willing to keep to
unorthodox views. Additionally, in a futarchy, the relevant thing is
not how high individual prices are, but which one of the two is
higher; if you are certain that bailouts are bad, but you see the
yes-bailout price is now $2.2 higher for some reason, you know that
something is wrong so, in theory, you might be able to pretty reliably
profit from that.
Absolutes and differentials

This is where we get to the crux of the real problem: it’s not clear
how you can. Consider a more extreme case than the yes/no bailouts
decision: a company using a futarchy to determine how much to pay
their CEO. There have been studies suggesting that ultra-high-salary
CEOs actually do not improve company performance - in fact, much the
opposite. In order to fix this problem, why not use the power of
futarchy and the market decide how much value the CEO really provides?
Have a prediction market for the company’s performance if the CEO
stays on, and if the CEO jumps off, and take the CEO’s salary as a
standard percentage of the difference. We can do the same even for
lower-ranking executives and if futarchy ends up being magically
perfect even the lowliest employee.

Now, suppose that you, as an analyst, predict that a company using
such a scheme will have a share price of $7.20 in twelve months if the
CEO stays on, with a 95% confidence interval of $2.50 (ie. you’re 95%
sure the price will be between $4.70 and $9.70). You also predict that
the CEO’s benefit to the share price is $0.08; the 95% confidence
interval that you have here is from $0.03 to $0.13. This is pretty
realistic; generally errors in measuring a variable are proportional
to the value of that variable, so the range on the CEO will be much
lower. Now suppose that the prediction market has the token price of
$7.70 if the CEO stays on and $7.40 if they leave; in short, the
market thinks the CEO is a rockstar, but you disagree. But how do you
benefit from this?

The initial instinct is to buy “no” shares and short-sell “yes”
shares. But how many of each? You might think “the same number of
each, to balance things out”, but the problem is that the chance the
CEO will remain on the job is much higher than 50%. Hence, the “no”
trades will probably all be reverted and the “yes” trades will not, so
alongside shorting the CEO what you are also doing is taking a much
larger risk shorting the company. If you knew the percentage change,
then you could balance out the short and long purchases such that on
net your exposure to unrelated volatility is zero; however, because
you don’t, the risk-to-reward ratio is very high (and even if you did,
you would still be exposed to the variance of the company’s global
volatility; you just would not be biased in any particular direction).

>From this, what we can surmise is that futarchy is likely to work well
for large-scale decisions, but much less well for finer-grained tasks.
Hence, a hybrid system may work better, where a futarchy decides on a
political party every few months and that political party makes
decisions. This sounds like giving total control to one party, but
it’s not; note that if the market is afraid of one-party control then
parties could voluntarily structure themselves to be composed of
multiple groups with competing ideologies and the market would prefer
such combinations; in fact, we could have a system where politicians
sign up as individuals and anyone from the public can submit a
combination of politicians to elect into parliament and the market
would make a decision over all combinations (although this would have
the weakness that it is once again more personality-driven).
Futarchy and Protocols and DAOs

All of the above was discussing futarchy primarily as a political
system for managing government, and to a lesser extent corporations
and nonprofits. In government, if we apply futarchy to individual
laws, especially ones with relatively small effect like “reduce the
duration of patents from 20 years to 18 years”, we run into many of
the issues that we described above. Additionally, the fourth argument
against futarchy mentioned above, the complexity of values, is a
particular sore point, since as described above a substantial portion
of political disagreement is precisely in terms of the question of
what the correct values are. Between these concerns, and political
slowness in general, it seems unlikely that futarchy will be
implemented on a national scale any time soon. Indeed, it has not even
really been tried for corporations. Now, however, there is an entirely
new class of entities for which futarchy might be much better suited,
and where it may finally shine: DAOs.

To see how futarchy for DAOs might work, let us simply describe how a
possible protocol would run on top of Ethereum:

    Every round, T new DAO-tokens are issued. At the start of a round,
anyone has the ability to make a proposal for how those coins should
be distributed. We can simplify and say that a "proposal" simply
consists of "send money to this address"; the actual plan for how that
money would be spent would be communicated on some higher-level
channel like a forum, and trust-free proposals could be made by
sending to a contract. Suppose that n such proposals, P[1] ... P[n],
are made.
    The DAO generates n pairs of assets, R[i] and S[i], and randomly
distributes the T units of each type of token in some fashion (eg. to
miners, to DAO token holders, according to a formula itself determined
through prior futarchy, etc). The DAO also provides n markets, where
market M[i] allows trade between R[i] and S[i].
    The DAO watches the average price of S[i] denominated in R[i] for
all markets, and lets the markets run for b blocks (eg. 2 weeks). At
the end of the period, if market M[k] has the highest average price,
then policy P[k] is chosen, and the next period begins.
    At that point, tokens R[j] and S[j] for j != k become worthless.
Token R[k] is worth m units of some external reference asset (eg. ETH
for a futarchy on top of Ethereum), and token S[k] is worth z DAO
tokens, where a good value for z might be 0.1 and m self-adjusts to
keep expenditures reasonable. Note that for this to work the DAO would
need to also sell its own tokens for the external reference asset,
requiring another allocation; perhaps m should be targeted so the
token expenditure to purchase the required ether is zT.

Essentially, what this protocol is doing is implementing a futarchy
which is trying to optimize for the token’s price. Now, let’s look at
some of the differences between this kind of futarchy and
futarchy-for-government.

First, the futarchy here is making only a very limited kind of
decision: to whom to assign the T tokens that are generated in each
round. This alone makes the futarchy here much “safer”. A
futarchy-as-government, especially if unrestrained, has the potential
to run into serious unexpected issues when combined with the
fragility-of-value problem: suppose that we agree that GDP per capita,
perhaps even with some offsets for health and environment, is the best
value function to have. In that case, a policy that kills off the
99.9% of the population that are not super-rich would win. If we pick
plain GDP, then a policy might win that extremely heavily subsidizes
individuals and businesses from outside relocating themselves to be
inside the country, perhaps using a 99% one-time capital tax to pay
for a subsidy. Of course, in reality, futarchies would patch the value
function and make a new bill to reverse the original bill before
implementing any such obvious egregious cases, but if such reversions
become too commonplace then the futarchy essentially degrades into
being a traditional democracy. Here, the worst that could happen is
for all the N tokens in a particular round to go to someone who will
squander them.

Second, note the different mechanism for how the markets work. In
traditional futarchy, we have a zero-total-supply asset that is traded
into existence on a derivatives market, and trades on the losing
market are reverted. Here, we issue positive-supply assets, and the
way that trades are reverted is that the entire issuance process is
essentially reverted; both assets on all losing markets become worth
zero.

The biggest difference here is the question of whether or not people
will participate. Let us go back to the earlier criticism of futarchy,
that it is irrational to participate because it is a zero-sum game.
This is somewhat of a paradox. If you have some inside information,
then you might think that it is rational to participate, because you
know something that other people don’t and thus your expectation of
the eventual settlement price of the assets is different from the
market’s; hence, you should be able to profit from the difference. On
the other hand, if everyone thinks this way, then even some people
with inside information will lose out; hence, the correct criterion
for participating is something like “you should participate if you
think you have better inside information than everyone else
participating”. But if everyone thinks this way then the equilibrium
will be that no one participates.

Here, things work differently. People participate by default, and it’s
harder to say what not participating is. You could cash out your R[i]
and S[i] coins in exchange for DAO tokens, but then if there’s a
desire to do that then R[i] and S[i] would be undervalued and there
would be an incentive to buy both of them. Holding only R[i] is also
not non-participating; it’s actually an expression of being bearish on
the merits of policy P[i]; same with holding only S[i]. In fact, the
closest thing to a “default” strategy is holding whatever R[i] and
S[i] you get; we can model this prediction market as a zero-supply
market plus this extra initial allocation, so in that sense the “just
hold” approach is a default. However, we can argue that the barrier to
participation is much lower, so participation will increase.

Also note that the optimization objective is simpler; the futarchy is
not trying to mediate the rules of an entire government, it is simply
trying to maximize the value of its own token by allocating a spending
budget. Figuring out more interesting optimization objectives, perhaps
ones that penalize common harmful acts done by existing corporate
entities, is an unsolved challenge but a very important one; at that
point, the measurement and metric manipulation issues might once again
become more important. Finally, the actual day-to-day governance of
the futarchy actually does follow a hybrid model; the disbursements
are made once per epoch, but the management of the funds within that
time can be left to individuals, centralized organizations,
blockchain-based organizations or potentially other DAOs. Thus, we can
expect the differences in expected token value between the proposals
to be large, so the futarchy actually will be fairly effective - or at
least more effective than the current preferred approach of “five
developers decide”.
Why?

So what are the practical benefits of adopting such a scheme? What is
wrong with simply having blockchain-based organizations that follow
more traditional models of governance, or even more democratic ones?
Since most readers of this blog are already cryptocurrency advocates,
we can simply say that the reason why this is the case is the same
reason why we are interested in using cryptographic protocols instead
of centrally managed systems - cryptographic protocols have a much
lower need for trusting central authorities (if you are not inclined
to distrust central authorities, the argument can be more accurately
rephrased as “cryptographic protocols can more easily generalize to
gain the efficiency, equity and informational benefits of being more
participatory and inclusive without leading to the consequence that
you end up trusting unknown individuals”). As far as social
consequences go, this simple version of futarchy is far from utopia,
as it is still fairly similar to a profit-maximizing corporation;
however, the two important improvements that it does make are (1)
making it harder for executives managing the funds to cheat both the
organization and society for their short-term interest, and (2) making
governance radically open and transparent.

However, up until now, one of the major sore points for a
cryptographic protocol is how the protocol can fund and govern itself;
the primary solution, a centralized organization with a one-time token
issuance and presale, is basically a hack that generates initial
funding and initial governance at the cost of initial centralization.
Token sales, including our own Ethereum ether sale, have been a
controversial topic, to a large extent because they introduce this
blemish of centralization into what is otherwise a pure and
decentralized cryptosystem; however, if a new protocol starts off
issuing itself as a futarchy from day one, then that protocol can
achieve incentivization without centralization - one of the key
breakthroughs in economics that make the cryptocurrency space in
general worth watching.

Some may argue that inflationary token systems are undesirable and
that dilution is bad; however, an important point is that, if futarchy
works, this scheme is guaranteed to be at least as effective as a
fixed-supply currency, and in the presence of a nonzero quantity of
potentially satisfiable public goods it will be strictly superior. The
argument is simple: it is always possible to come up with a proposal
that sends the funds to an unspendable address, so any proposal that
wins would have to win against that baseline as well.

So what are the first protocols that we will see using futarchy?
Theoretically, any of the higher-level protocols that have their own
coin (eg. SWARM, StorJ, Maidsafe), but without their own blockchain,
could benefit from futarchy on top of Ethereum. All that they would
need to do is implement the futarchy in code (something which I have
started to do already), add a pretty user interface for the markets,
and set it going. Although technically every single futarchy that
starts off will be exactly the same, futarchy is
Schelling-point-dependent; if you create a website around one
particular futarchy, label it “decentralized insurance”, and gather a
community around that idea, then it will be more likely that that
particular futarchy succeeds if it actually follows through on the
promise of decentralized insurance, and so the market will favor
proposals that actually have something to do with that particular line
of development.

If you are building a protocol that will have a blockchain but does
not yet, then you can use futarchy to manage a “protoshare” that will
eventually be converted over; and if you are building a protocol with
a blockchain from the start you can always include futarchy right into
the core blockchain code itself; the only change will be that you will
need to find something to replace the use of a “reference asset” (eg.
264 hashes may work as a trust-free economic unit of account). Of
course, even in this form futarchy cannot be guaranteed to work; it is
only an experiment, and may well prove inferior to other mechanisms
like liquid democracy - or hybrid solutions may be best. But
experiments are what cryptocurrency is all about.