NEW YORK (InsideBitcoins) — Crowdfunding is a topic that often comes up in the bitcoin space because many people would like to know how cryptocurrency may be able to bring more efficiency to this growing phenomenon. Whether the money is going towards an entrepreneurial endeavor or a charity, it’s obvious that crowdfunding platforms, such as Kickstarter and Indiegogo, can be powerful fundraising tools. When bitcoin is integrated into the concept of crowdfunding, we could be looking at new ways to fund everything from online content to general public goods.

Assurance contracts

Although they often go by a different name, assurance contracts are the basis for how crowdfunding works on the Internet today. The basic premise is that a bunch of people will donate to some sort of cause, but they will only be charged for their donation if a certain threshold of donations is met by the entire crowd.

These are the sorts of crowdfunding campaigns seen on Kickstarter where a new company will begin shipping an interesting new product if they receive a certain amount of funds before the deadline. This sort of crowdfunding method has been used by many different startups in the past few years, including Soylent and Oculus Rift. However, it’s likely that this method of raising funds will not work for certain public goods.

What about the freeloaders?

The problem with using assurance contracts for public goods — like a community’s infrastructure, parks or even national defense — is figuring out who’s going to donate to the cause. In economics, this is known as the free rider problem. Everyone can benefit from a public good, but funding for that good does not need to come via equal donations by everyone who will enjoy the benefits of that good. This can lead to the underproduction or, in the case of a crowdfunding campaign, the non-production of a public good. Government solves this issue through taxation and the use of force, but there may be a more peaceful approach in our future.

Lighthouse and Truthcoin are two relatively new bitcoin platforms that could eventually be used to fund public goods, including the bitcoin development process. Lighthouse is on the verge of a beta release as a separate bitcoin wallet, while Truthcoin has plans to be added as a sidechain to bitcoin in the future. Both of these projects may eventually turn towards dominant assurance contracts to solve the free rider problem.

A dominant assurance contract is similar to a normal assurance contract, but it also comes with an added incentive for donors. This incentive comes by way of the entrepreneur who will reward individuals for donating to the public good — no matter if the funding goal is met or not. For example, an entrepreneur may offer a 10% kickback on donations if it turns out that the project did not get funded. Economist Alex Tabarrok has a simple explanation of the entire process on his blog.

Whether or not dominant assurance contracts are the perfect solution to the free rider problem is still up for debate, but it can at least be seen as an improvement over a traditional assurance contract.

How does the blockchain know what happened?

While dominant assurance contracts could very well be the proper option for incentivizing more donations for public goods, there is still the issue of the blockchain having no idea of what is going on in meat space. For these contracts to have any sort of credibility, they need to be enforceable. There are generally two different camps to look at for this aspect of bitcoin crowdfunding.

The Truthcoin solution is to create a decentralized prediction market as a sidechain to bitcoin. “Trustless dominant assurance contracts” can then be built as a feature on top of the base Truthcoin protocol. This prediction market would use incentive structures based on game theory to create honest voters on the outcomes of real life events.

This is a decentralized approach that could have some promise, but the reality is that it’s still quite experimental. It should be noted that this is a gross simplification of how crowdfunding would work with Truthcoin, and a more in-depth description can be found in Extra-Predictive Applications of Prediction Markets by Paul Sztorc (the creator of Truthcoin).

On the other side of the fence is the use of trusted oracles. Instead of searching for a completely decentralized solution, there are many individuals in the bitcoin community who believe that having trusted data feeds tell the blockchain whether or not an event took place in the real world is a fine solution. One proposal uses a vote of three trusted oracles rather than depending on a monolithic decider.

Both approaches are bound to be tested in the real world over the next few years, and some entrepreneurs are already building businesses around the idea of becoming a trusted oracle. Reality Keys is one such company that plans to do nothing but publish reliable data that can be used to finalize bets on the blockchain.

If it turns out that these theoretical methods of raising funds for public goods actually work, then it will be interesting to watch the ramifications of these new technologies play out in society. Both bitcoin and governments function on differing consensus algorithms, and some governments may be overdue for an upgrade in the consensus department. These are still considered “out there” ideas by most, and only time will tell if society feels comfortable with the idea of choosing crowdfunding over taxation.

You can follow @kyletorpey on Twitter.

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