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Decentralized Arbitration & Its Implications

An explanation of decentralized arbitration and dispute resolution along with their implications.

Before we start, here are some key terms to know:

  • Blockchains are essentially very secure, distributed, and decentralized databases.
  • Smart contracts are lines of code that automatically execute a function when given an input — just like a vending machine.
  • Oracles are software agents that input external data into smart contracts.

Smart contracts are better defined as “censorship-resistant, tamper-proof deterministic digital agreements.” Sounds like a mouthful, but smart contracts really are digital agreements that automatically execute based on certain parameters, all without trusted third parties or the ability to stop them from being enforced.

Although it is a huge leap forward from the probabilistic contracts every one is used to dealing with, smart contracts on their own don’t eliminate the possibility of disputes arising. As society moves away from “brand based” agreements to agreements based on and executed by mathematics, there will be areas where objective data is insufficient to solve certain problems.

Imagine a scenario where Bob enters into a smart contract agreement with Alice on a decentralized services provider platform. Bob hires Alice, who could be from an entirely different jurisdiction, to make a website for him in two weeks. At the end of the two weeks, the smart contract where Bob’s funds’ funds are held in escrow needs to be released so that Alice can be paid for her services. However, the website isn’t exactly what Bob envisioned when they signed the terms of agreement, and doesn’t want the escrow to go through. How can this situation be resolved while remaining in a trustless environment? An oracle that handles purely objective data would not be sufficient to arbitrate such a case. A decentralized online dispute resolution protocol solves this type of issue.

There are several of these protocols in the space today, but the most prominent are Kleros Court and Aragon Court. A high-level overview of how dispute resolution works using these protocols is where a party who raises a dispute on the outcome of a smart contract can send the dispute to the court, which involves paying arbitration fees to the jurors adjudicating the case. The users of the protocol, who may be knowledgeable about the specific topic pertaining to the case, stake their respective token for the chance to be selected as a juror on this dispute. Randomly selected jurors then analyze the evidence that the parties of the dispute provide for the case. The jurors then vote on which party should win the dispute, and when a consensus has been reached, the funds are released to that party. Jurors who voted in coherence with the consensus are then paid the arbitration fees by the losing party, while jurors who didn’t lose their stake.

Should a party be unhappy with the dispute, they can put up another stake to have the case appealed, and a new set of jurors bigger than the previous round will arbitrate the case. This process can keep going on with new rounds of jurors as long as the appellant keeps staking more which pays the arbitration fees of the new jurors. This makes it very hard to bribe jurors as appeals keep crowd-sourcing the responses from more and more jurors at an exponential rate. This specifically is a massive advancement compared to how traditional litigation is done, where jurors can be bribed easily by powerful entities.

What about use cases beyond dispute resolution?

Decentralized arbitration in general is a massive leap forward in the blockchain space. It allows for the system to be complete with the use of Trust as a Service to handle disputes that are inevitable in economies of scale. These protocols can be used to create interesting dApps such as escrow systems and curated tokens for decentralized exchanges; these dApps are where the real potential lies.

For example, these protocols can be used to create curated Proof of Person lists where people can prove whether they are human or not in a decentralized way. Others can challenge cases where they believe that the submitted person is not a human and earn economic rewards for doing so. In effect, this would create a provably true database of humans that could have significant ramifications not only in the blockchain space, but outside of it as well.

To illustrate the immensity of such a realization, imagine having the disbursement of your will completely automated by smart contracts and decentralized dispute resolution. A contract could be made such that your funds would be distributed to your heirs in the event that your private key had not been signed for a specified period of time. The heirs could prove their inheritance through these protocols and if a dispute were to arise, it would be sent to the jurors to decide. These jurors could be specified in the original contract that contained the will to only be verified humans from a specific jurisdiction.

This is just a small example, but the potential use cases are endless. Such a system would change how people interact with each other, and these protocols allow for such a system to exist.

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An example of how Kleros Court would be used in a decentralized e-commerce platform

These types of protocols can also act as a type of oracle while not requiring dedicated oracles to provide specific information. Chainlink (if you don’t know what Chainlink is, check out my previous article) requires oracle networks to be set up in order to deliver data on-chain about a specific data feed. At the moment, these data feeds are mostly limited to exchange rate information because that is something that has a high enough volume to warrant the high cost of setting up an oracle network. Some contracts may require data without having the time to set up an oracle network or even in cases where certain information cannot be retrieved through an API.

Chainlink solves the oracle problem from an objective perspective, but the network cannot currently handle the arbitration of disputes that may arise in smart contracts or subjective data that requires human input. These protocols fill that niche and can help Chainlink fully solve the oracle problem. It is more impractical to use them for objective data such as price and exchange rates, which Chainlink excels at, but for any other type of data that can be subjective, they could become the de facto way for putting that type of data on-chain in a decentralized manner.

It’s important to see the difference in how Chainlink and these protocols operate as an oracle mechanism. Chainlink is perfect for trustless derivatives for example; entities betting against each other don’t have to care who their counter party is, as long as they have a guarantee to be paid in the event that they win. The only thing required for the execution of that bet is the objective data pertaining to it, such as weather data or price feeds. This works well for these types of objective use cases, but what about the use of smart contracts in more subjective areas, such as the sector of languages for instance?

If Hector is a translator, how can he advertise himself on a decentralized platform by proving that he can actually translate well? How can such a thing be verified in a trustless manner? Kleros is solving this problem by allowing humans, who may work professionally as translators or are fluent in that language, to decide whether or not he is capable of translating well. Hector could use a dApp that leverages decentralized arbitration such as Linguo, a trustless translation dApp, to prove his translating capabilities to others while people who are just pretending to be good at translating would be weeded out.

Take that specific scenario and apply it any kind of smart contract that could be created. With this type of system along with curated lists of verified humans, trustless transactions for these types of specialized use cases can finally be realized. Instead of trusting someone based on their word that they can do something, these protocols would be able to determine whether or not someone has a specific skill, which leads to the ability to hire contractors without the need for a trusted third party. Extrapolating from that, this method of judging honesty from claims in the real world allows for truth, in the highest sense of the word, to be interpolated into blockchains, not only from a purely objective standpoint but also from a subjective one.

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This article is for educational purposes only. None of what was stated in this article should be construed as financial advice.

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