The Value of Self-Enforcing Protocols
By Bruce Schneier
There are several ways two people can divide a piece of cake in half. One way is to find someone impartial to do it for them. This works, but it requires another person. Another way is for one person to divide the piece, and the other person to complain (to the police, a judge, or his parents) if he doesn't think it's fair. This also works, but still requires another person – at least to resolve disputes. A third way is for one person to do the dividing, and for the other person to choose the half he wants.
That third way, known by kids, pot smokers, and everyone else who needs to divide something up quickly and fairly, is called cut-and-choose. People use it because its a self-enforcing protocol: a protocol designed so that neither party can cheat.
Self-enforcing protocols are useful because they don't require trusted third parties. Modern systems for transferring money -- checks, credit cards, PayPal - require trusted intermediaries like banks and credit card companies to facilitate the transfer. Even cash transfers require a trusted government to issue currency, and they take a cut in the form of seigniorage. Modern contract protocols require a legal system to resolve disputes. Modern commerce wasn't possible until those systems were in place and generally trusted, and complex business contracts still aren't possible in areas where there is no fair judicial system. Barter is a self-enforcing protocol: nobody needs to facilitate the transaction or resolve disputes. It just works.
Self-enforcing protocols are safer than other types because participants don't gain an advantage from cheating. Modern voting systems are rife with the potential for cheating, but an open show of hands in a room – one that everyone in the room can count for himself – is self-enforcing. On the other hand, theres no secret ballot, late voters are potentially subjected to coercion, and it doesn't scale well to large elections. But there are mathematical election protocols that have self-enforcing properties, and some cryptographers have suggested their use in elections.
Heres a self-enforcing protocol for determining property tax: the homeowner decides the value of the property and calculates the resultant tax, and the government can either accept the tax or buy the home for that price. Sounds unrealistic, but the Greek government implemented exactly that system for the taxation of antiquities. It was the easiest way to motivate people to accurately report the value of antiquities.
A VAT, or value-added tax, is a self-enforcing alternative to sales tax. Sales tax is collected on the entire value of the thing at the point of retail sale; both the customer and the storeowner want to cheat the government. But VAT is collected at every step between raw materials and that final customer; its the difference between the price of the materials sold and the materials bought. Buyers wants official receipts with as high a purchase price as possible, so each buyer along the chain keeps each seller honest. Yes, theres still an incentive to cheat on the final sale to the customer, but the amount of tax collected at that point is much lower.
Of course, self-enforcing protocols aren't perfect. For example, someone in a cut-and-choose can punch the other guy and run away with the entire piece of cake. But perfection isn't the goal here; the goal is to reduce cheating by taking away potential avenues of cheating. Self-enforcing protocols improve security not by implementing countermeasures that prevent cheating, but by leveraging economic incentives so that the parties don't want to cheat.
One more self-enforcing protocol. Imagine a pirate ship that encounters a storm. The pirates are all worried about their gold, so they put their personal bags of gold in the safe. During the storm, the safe cracks open, and all the gold mixes up and spills out on the floor. How do the pirates determine who owns what? They each announce to the group how much gold they had. If the total of all the announcements matches whats in the pile, it's divided as people announced. If its different, then the captain keeps it all. I can think of all kinds of ways this can go wrong -- the captain and one pirate can collude to throw off the total, for example -- but it is self-enforcing against individual misreporting.
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