Can Blockchain Solve the Hold-Up Problem in Contracts?

39 Pages Posted: 13 May 2019

See all articles by Richard Holden

Richard Holden

University of New South Wales (UNSW)

Anup Malani

University of Chicago - Law School; University of Chicago Pritzker School of Medicine; Resources for the Future; National Bureau of Economic Research (NBER)

Date Written: May 2019

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.

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Suggested Citation

Holden, Richard and Malani, Anup, Can Blockchain Solve the Hold-Up Problem in Contracts? (May 2019). NBER Working Paper No. w25833. Available at SSRN: https://ssrn.com/abstract=3387189

Richard Holden (Contact Author)

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

Anup Malani

University of Chicago - Law School ( email )

1111 E. 60th St.
Chicago, IL 60637
United States
773-702-9602 (Phone)
773-702-0730 (Fax)

HOME PAGE: http://www.law.uchicago.edu/faculty/malani/

University of Chicago Pritzker School of Medicine

Chicago, IL 60637
United States

Resources for the Future

1616 P Street, NW
Washington, DC 20036
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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