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Can Blockchain Solve the Hold-up Problem in Contracts?

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  • Richard T. Holden
  • Anup Malani

Abstract

Two parties sign a contract but before they fully perform they modify the contract. Should courts enforce the modified agreement? The modification may enable efficient trade in response to changed circumstances, or one party may have made an efficient relationship-specific investment and then been held-up by the other. Courts have had difficulty tackling this problem because the facts required to discriminate between the two situations are non-verifiable. A private remedy is for the parties to write a contract that is robust to hold-up or that makes the facts relevant to modification verifiable. But implementing such remedies requires commitment to the provisions, i.e., they themselves are subject to non-compliance. Conventional contract technology, e.g., the use of liquidated damages, to ensure commitment are disfavored by courts and subject to renegotiation. Smart contracts written on blockchain ledgers may offer a solution. We explain the basic economics of these technologies. We argue that they can used to implement liquidated damages without court involvement and thereby obtain commitment to renegotiation design and revelation mechanisms. We address the hurdles courts may impose to use of smart contracts and argue that sophisticated parties’ ex ante commitment to them may lead courts to allow their use as pre-commitment devices.

Suggested Citation

  • Richard T. Holden & Anup Malani, 2019. "Can Blockchain Solve the Hold-up Problem in Contracts?," NBER Working Papers 25833, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:25833
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    Cited by:

    1. Benito Arruñada, 2020. "Prospects of blockchain in contract and property," Economics Working Papers 1696, Department of Economics and Business, Universitat Pompeu Fabra.
    2. de Rassenfosse, Gaetan & Higham, Kyle, 2019. "Decentralising the Patent System," SocArXiv qzmf8, Center for Open Science.
    3. Joshua S. Gans, 2019. "The Fine Print in Smart Contracts," NBER Working Papers 25443, National Bureau of Economic Research, Inc.
    4. Olivier Meier & Aurélie Sannajust, 0. "The smart contract revolution: a solution for the holdup problem?," Small Business Economics, Springer, vol. 0, pages 1-16.
    5. Massimiliano Vatiero, 2018. "Smart contracts and transaction costs," Discussion Papers 2018/238, Dipartimento di Economia e Management (DEM), University of Pisa, Pisa, Italy.
    6. Anil Savio Kavuri & Alistair Milne, 2019. "FinTech and the future of financial services: What are the research gaps?," CAMA Working Papers 2019-18, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.

    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law

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