Recipe for an Open Source Economy

Posted on October 8, 2013

Last time, I said "our society should reward contributions to the common pool of knowledge in proportion to their value to society." That sounds pretty sketchy, right? Don't worry, I'm no communist. I'm looking for an answer that works when individuals act on their own initiative. Let's talk concretely.

Imagine a system that tracks all the groceries in your house, suggests meals to cook and helps make shopping lists. Cool, right? The sort of technological advance that I'd like to incentivize. Let's imagine Alan thinks it'd be cool too, and he values such a development at $300. Note we're talking only about the information - the ideas, the designs and software of the system. Alan will still have to buy the physical components to actually use it. Here's a proposition: what if he sells off his anticipated benefit?

The central idea here is that of a prediction contract - a financial instrument entitling the holder to money if a certain prediction comes true. The prediction we're interested in here is something like "there will be developed a grocery-tracking computer system with features x, y and z". Alan has decided such a system would make his life $300 easier, so he's happy being up to $300 poorer in trade. For simplicity's sake I'll say prediction contracts always pay out at $1. So Alan sells 300 contracts for, say, $0.20 each. Up a total of $60. If nobody figures out the grocery-tracking problem, he keeps it. If the prediction comes true - if someone or some group successfully designs a system meeting the spec - Alan has to pay out the $300 to the contract holders. His net monetary loss is $240, but since the system is worth $300 to him, he gains $60 in net utility. The effect is that Alan doesn't care whether the prediction comes true anymore.

Wikipedia has a decent article on prediction markets. The idea of prediction markets isn't mine, but the concept of anticipated benefit transfer and it's application to incentivizing the production of public goods is an original contribution. Conventionally, prediction markets are used for betting on world events; prices on these markets reflect the market's believed probability of a given event happening.

At this point, you can rightly ask why Alan should make the sale in the first place. All it accomplishes for him is trading a potential windfall - new invention - for a smaller guaranteed return. If the price he and his buyer agree on accurately reflects the probability of the project's successful completion - $0.50 per contract for a 50% probability and so on - the law of large numbers says he'd get the same result without any of the tedium of selecting predictions, deciding on their value and selling the contracts.

That line of argument holds water, though I have an inkling there may be more going on here than meets the eye - more on that later. Setting aside whether it's rational to sell off anticipated benefit, Alan can use the prediction market as a means of cheaper and more efficient charity. Alan's sale of prediction contracts, combined with others' like him, may create sufficient financial incentive to get the goal completed. If not, he is much better off financially than if he had donated the money to the Stuff To Make Household Chores Easier Foundation. Furthermore, he doesn't have to figure out if the foundation is capable of completing the project, or if the project is possible at all. Price competition from multiple bidders should mean he ends up paying a price determined by the complexity of the project and the amount of contributions in contracts from others, rather than a donation amount clouded by uninformed perceptions.

At this point I'll acknowledge the work these ideas are based upon. I was first introduced to these ideas in a paper published in the online journal First Monday, "The Wall Street Performer Protocol: Using Software Completion Bonds to Fund Open Source Software Development" by Chris Rasch. Rasch's work is in turn based on the concept of social policy bonds, invented by Ronnie Horesh. Horesh and Rasch both talk about the concept in terms of "bonds", I prefer the prediction market terminology. Note that Horesh and Rasch's bonds have no expiry date, while prediction contracts always do. There would be no way to profit by betting no if a seller was always liable to pay the face value of a contract.

Let's look at this from the perspective of the person buying these prediction contracts. Brenda has the technical and business skills necessary to build a system meeting the prediction's specifications. She buys up some contracts and begins work. Carl and Dani also buy some. Since they get paid if the project is completed satisfactorily regardless of who turns it in, all three of them work together in whatever way they think is most likely to get the system built. As the project gets closer and closer to completion, the market value of the contracts rises. Dani gets a job offer and has to stop working on the project. She sells her contracts to Carl, making a profit based on the progress to date. When the project is completed, Carl and Brenda get paid, repay their investors and move on to the next thing.

So there's the rosy eyed promise of the idea - prediction markets can be used to efficiently pay for libre engineering in a way that incentivizes open collaboration between any number of participants and rewards partial progress. If people sold prediction contracts in a way that reflected their desires, we could make much faster progress as a society in the scientific, technological and humanitarian arenas.

That's enough for now, I think. Next time is the "Halp! I'm stuck!" post, where we delve into the not-so-rosy questions like "Does it make sense for anyone to sell prediction contracts in this manner?" and "How do you decide the value of a prediction contract?"

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