What are Decentralized Markets?

Sam Patterson of OB1 explains how Bitcoin and multisig transactions enable open and decentralized online e-commerce.

Decentralized markets are an emerging technology which give people the ability to participate in online commerce that is completely different from the traditional centralized model. Instead of having a company with a website offer a central meeting place for buyers and sellers, decentralized markets work by having buyers and sellers connect directly to each other. This is accomplished by running a peer-to-peer program on their computer, and using digital currencies such as Bitcoin for payment.

Online Commerce is Centralized

Online commerce is continually becoming a larger part of how we all do business. Hundreds of billions of dollars worth of trade occurs annually, and the percentage of trade occurring online grows each year.

This commerce is being done mostly through large companies, such as Amazon, eBay, Etsy, and Alibaba. These companies provide a service to users. Sellers have a platform of millions of shoppers; shoppers have many goods and services to purchase on one single website. However, providing this service requires employees and servers, which are expensive. Companies recoup their costs – and make a profit – by charging their users fees. These fees vary depending on the company and product category, but are frequently 10% or more per item sold. Sellers typically pay this cost directly, but buyers pay indirectly via higher prices.

In addition to charging fees, these companies also collect data about their users’ purchasing and selling habits. Because most commerce on these platforms is conducted with payment methods that require identification, companies are able to build extensive personal profiles about individual users.

Since these platforms are centrally controlled, they are able to prohibit trade from occurring. They may restrict trade for any number of reasons, the most obvious being in order to comply with the laws in their legal jurisdiction. Apart from censorship to comply with local laws, they also may censor trade for products and services that are morally objectionable, politically incorrect, or represent a threat to their own business. Popular platform Etsy decided in September 2014 to prevent the sale of merchandise from the Washington Redskins NFL team because they considered it discriminatory; Amazon banned the sale of confederate flag merchandise in June 2015. In September 2015, Amazon also prohibited the sale of video-streaming devices from competitors on their platform in order, some would say, to boost sales of their own device.

Enter Decentralized Markets

There are now several decentralized markets which allow people to engage in trade directly with each other. Instead of relying on the centrally-controlled servers of the companies, a decentralized market operates by employing its users’ own computers as the infrastructure.

Decentralized markets are nascent. Only a handful exist, and are still largely under development. There are different approaches to achieving decentralized trade. One approach is using a blockchain directly. These markets will place product listing information directly into a blockchain, allowing buyers to reference the blockchain and purchase from there. Another method is to create a network of nodes that all talk to each other directly and don’t reference a blockchain, similar to BitTorrent.

Some implementations use a contracting system to ensure that all parties to the trade are clear on the details. When a seller lists an item, the software automatically signs the listing with the seller’s digital signature. When a buyer agrees to buy the item, they also sign. These signatures – along with any details necessary for the transaction to take place – are appended to the contract through each step. In this way an unchangeable record of trade has been created that proves both parties participated and the details they agreed to.

The benefits of decentralized trade revolve around the removal of the middleman. There are no fees to list products and no fees when products are sold. There are no fees at all since trade is occurring directly between the buyer and seller. There is no central organization that requires registration or collects data on users’ spending habits. There are no restrictions on trade, no terms and conditions to agree with. The marketplace is only dependent on having a computer and the Internet; there are no geographical restrictions.

Trust and Reputation

In centralized markets, the platform itself tries to prevent fraud and protect its users (with varying success). But how can users in a decentralized system trust each other? What prevents a seller from taking the bitcoins and never shipping the good?

There are multiple ways to prevent fraud in decentralized markets, and they center around a unique feature of Bitcoin called multisignature transactions. A typical Bitcoin transaction involves two people – a sender and a receiver. The sender controls the bitcoins exclusively and choses to send them to the receiver. A multisignature transaction is different. Instead of having one sender, control over the bitcoins is divided between multiple senders who must agree before the bitcoins can move to the receiver.

There are multiple multisignature arrangements. One common arrangement is 2-of-3, which means that control over the bitcoins is divided between three people, and two of them must agree before they can be sent anywhere. Another is 2-of-2, which means that control is divided between two people and bitcoins can only be spent if they both agree.

2-of-3 allows for a buyer and seller to add a trusted third party to the transaction in case something goes wrong. Instead of the buyer directly sending bitcoins to the seller, they will instead fund the multisig address which has divided control between the buyer, seller, and this third party. If the seller then ships the good or provides the service, and the buyer is happy, they both agree to release funds and the seller gets the money. If there is a dispute, then either party can reach out to the third party, and she can decide with whom to join in releasing funds. In this way, as long as the third party is trustworthy, fraud is difficult in this 2-of-3 multisig system.

2-of-2 goes a step further and doesn’t even bring in a third party. The buyer instead funds a multisig address that is jointly controlled by both buyer and seller. If the seller ships the good or provides the service, then they both join to release the funds to the seller. Some markets also include an incentive for both parties to act in good faith by having each party add a deposit into the 2-of-2 account that only gets released once trade finalizes. In theory there is no incentive to defraud since your deposit would be lost, making it costly.

In addition to using multisig, some decentralized markets include reputation systems to give users a better understanding of who they are trading with, and to create an incentive to trade fairly so that users maintain a positive reputation. However, the creation of a decentralized reputation system that isn’t easily gamed is very difficult. These systems are only being implemented now, and we have yet to see if the current attempts will be successful in the long term.

Law Enforcement

In a centralized marketplace, law enforcement has the advantage of being able to work with the marketplace operator to ensure all the users of the platform are following the law. If the marketplace operators aren’t cooperative, or if the marketplace is specifically designed for illegal activity (such as the infamous Silk Road), then law enforcement is able to physically shut down the marketplace and stop all commerce.

Decentralized markets present a new challenge to law enforcement. Since there is no central market operator, there is no one to work with to stop illegal activity, nor is there any way to shut down the entire system. Since trade is peer-to-peer, the only way to stop commerce is to stop each individual engaged in illegal activity from using the software directly. This is potentially a time-consuming process.

Fortunately, decentralized markets may not be very appealing for criminal activity. Some of the leading decentralized markets don’t employ anonymizing techniques to hide their users’ IP addresses, meaning any activity on the network could easily be monitored by law enforcement and tied to real-life identity. Also, when using a centralized marketplace, a criminal is placing the responsibility for maintaining privacy and security on the site operator. This is appealing to criminals because if the site is taken down, it will be the site operator who is held responsible. In a decentralized marketplace, each user runs their own store themselves and must take care of their own privacy and security. For users engaged in legal activity, this isn’t very difficult to do. But criminals will have law enforcement specifically looking for them, and if they’re caught they bear the entire responsibility themselves.

Since decentralized markets are so young and there’s been so little trade occurring so far, we haven’t yet seen if they’re used more frequently for cybercriminals than existing centralized underground markets.

Conclusion

Decentralized markets allow us to replicate, online, our in-person ability to buy and sell things to each other directly. This avoids middlemen, resulting in no fees and no restrictions on trade. This new type of commerce presents some new challenges to law enforcement, though it’s not clear yet that decentralized markets are very appealing to criminals. Decentralized markets are still largely being developed and are very young, but thanks to some unique qualities of Bitcoin, the technology now exists to trade directly and securely online with anyone in the world.

Sam Patterson is the COO of OB1, a company helping to develop the decentralized marketplace OpenBazaar. He writes and presents about Bitcoin and other emerging technologies that make people’s lives better.

Based in Washington, D.C., Coin Center is the leading non-profit research and advocacy center focused on the public policy issues facing cryptocurrency and decentralized computing technologies like Bitcoin and Ethereum. Our mission is to build a better understanding of these technologies and to promote a regulatory climate that preserves the freedom to innovate using permissionless blockchain technologies.