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Antitrust Enforcement Needs an Upgrade to Combat Digital Tacit Collusion by Blockchain Smart Contracts

Posted  March 11, 2022

By Jeff Shinder and Kristian Soltes

Antitrust enforcers need to upgrade their enforcement efforts to deal with the challenges of using a 19th Century statute to combat 21st Century digital tacit collusion.

Although the Sherman Act was enacted in 1890, its general proscriptions against restraints of trade are expected to apply to all manner of anticompetitive conduct in our fast-moving digital economy. That puts a premium on antitrust policy adapting to changing economic conditions, including rapid technological change, and policy makers and antitrust economists are often not up to the task.

These challenges are especially daunting in policing competition in the digital world of a blockchain, which is a type of shared database that keeps an immutable digital ledger of transactions. Blockchains can obscure the extent to which such transactions are coordinated because blockchain technology is complex and its potential applications and uses are incredibly varied. Without a deep understanding of the technology and its uses, antitrust enforcement cannot possibly keep up with its potential exploitation for anticompetitive ends.

These concerns are not theoretical; allegations of blockchains being abused for anticompetitive ends are already being heard by the courts. Existing antitrust jurisprudence is being applied to cases involving blockchains, and we can expect antitrust enforcement to target other questionable uses of blockchain. What we do not know, however, is how antitrust will handle the next iteration of blockchain technology: smart contracts.

Antitrust law has long had trouble reaching tacit forms of collusion such as price signaling involving seemingly independent conduct. Section 1 of the Sherman Act requires proof of an agreement to restrain trade. While such an agreement can be proven by inference, the law, as it’s currently interpreted, considers parallel conduct, without more, insufficient to show conspiracy. As a result, firms in highly concentrated markets can engage in price signaling to coordinate collusive outcomes and escape antitrust liability unless there is some additional “plus-factor” evidence of an express or implied agreement. This perceived gap in the law is further complicated by the increasing prevalence of algorithms that dictate pricing, allowing firms to coordinate pricing without any discernible agreement.

Enter smart contracts, a blockchain innovation that can further facilitate such tacit collusion. Smart contracts can essentially automate price signaling, and in doing so, strengthen the collusive trust between cartel members, while making detection by regulators more difficult. Antitrust enforcers better keep up.

Smart Contracts

In the words of Nick Szabo, the computer scientist who originally coined the term “smart contract” in 1996, smart contracts are “a set of promises, specified in digital form, including protocols which the parties perform on these promises.” In other words, smart contracts are essentially computer programs that automatically self-execute agreed-upon promises (such as the release of payments or goods, or the transfer of title) upon the occurrence of a specified event. Smart contracts can be implemented on public blockchains like the Ethereum Network, or they can be set up privately as permissioned blockchains, allowing great flexibility in determining the rules of the blockchain.

By taking advantage of the immutable and verifiable nature of blockchains, parties to a smart contract can be confident that their agreement will function precisely as intended, without the ability for one party to change or renege on their agreement. In other words, it eliminates counterparty risk and automates the execution of the parties’ promises. That can have profound cost-saving advantages.

Antitrust Implications

Antitrust law’s difficulty in reaching tacit forms of collusion is particularly problematic in the context of smart contracts. Signaling can be one such manifestation of tacit collusion, where competitors share information that allows them to converge prices at supracompetitive levels. Such signaling can also help conspirators monitor compliance with a price fixing scheme.  Absent evidence of an ex ante agreement to use smart contracts to facilitate collusion, it will be hard to prove collusion merely from the execution of tacit collusion through seemingly independent smart contracts.

For example, consider a group of suppliers who all use the same pricing algorithm to determine the optimal price and output of their products. This algorithm relies partially on data from competitors, which is available on the internet. While these competitors may have agreed to fix prices using the pricing algorithm, proving that agreement would be very difficult under current antitrust law. Each competitor could say, with some persuasive force, that its decision to adopt the pricing algorithm was made independently. Even if those competitors effectively coordinated pricing with their rivals—and thereby raised prices above competitive levels—the law says if their decisions were truly independent, they did not violate Section 1 of the Sherman Act. As a result, absent evidence that the suppliers somehow agreed to adopt the pricing algorithm for the purpose of fixing prices, the Sherman Act would not reach this conduct. This fact pattern would be even more elusive from an antitrust enforcement perspective if a third-party created and marketed the algorithm.

Smart contracts add an additional layer of complexity. In this example, the same competitors create this pricing algorithm on the blockchain. They do so for several reasons. They do not want their sensitive data available freely on the internet, so they share information on a public blockchain with only suppliers in the industry having private keys to access the underlying data. The suppliers also want assurance that all participants will adhere to their agreement. And the suppliers do not want an intermediary maintaining the algorithm or monitoring the participants’ pricing decisions. The immutable and consensus-based nature of blockchain therefore addresses these objectives.

The result is essentially the same – a group of competitors shares data and utilizes the algorithm when setting prices. But because the competitors are using a smart contract, there is no need for any ongoing communication between them and no middleman. There is no visible coordination. In fact, the smart contracts can be set up to automatically release the product at the algorithmic price, thereby fully automating the collusive transactions. Since activity on the blockchain is visible to the suppliers, it also immediately signals to the group if one supplier is cheating by discounting below the cartel price. The fact that all participants can trust each other without ongoing communication is a huge boon to the cohesiveness of a cartel.

Although such collusive conduct may occur on a public blockchain, the automatic built-in triggers controlling the pricing could effectively cloak the collusive nature of the arrangement. For antitrust enforcers, untangling legal, parallel conduct from anticompetitive collusion becomes exceedingly difficult.

There are countless ways to implement such a smart contract. Competitors can use the blockchain not only to algorithmically set prices but to optimally decide where to sell. Competitors that set up smart contracts on a permissioned blockchain (which is limited to designated participants) can control the behavior of the blockchain, governance of the blockchain, and access to the underlying data. A subgroup of blockchain participants could potentially even capture the blockchain through mining power, permitting them to control the operation of the entire blockchain, including smart contracts built on the blockchain. And in the future, artificial intelligence embedded in smart contracts could actually actively manage a cartel without involvement by the competitors, which would further complicate enforcement.

Of course, such activities can also introduce additional forms of antitrust exposure, like market allocation, group boycotts, or monopolization. Nevertheless, it is painfully clear that smart contracts can facilitate myriad tacit forms of collusion. Unless antitrust enforcers develop a sophisticated understanding of this technology, antitrust enforcement will be ill-equipped to detect and combat such potential collusion.

Enforcement Solutions

Many experts have long urged for antitrust reform to be able to better address tacit collusion. But irrespective of lawmaking, as an immediate step, antitrust enforcers must become versed in blockchain and specifically how blockchain can be used towards collusive ends. This is not an easy task, particularly because it is hard to recruit talent to the antitrust agencies when young technology buffs can make far more in the private sector.

Antitrust enforcers must either staff up on those who understand computer science and blockchain basics, or systematically consult with industry experts. For example, if tacit collusion on the blockchain is a product of an express agreement among competitors, enforcers need the expertise to persuasively argue and prove that. Enforcers need the expertise to not only analyze collusive agreements on blockchains, but to track off-chain and side-chain activity as well. Putting all the evidentiary pieces together will be critical. Otherwise, savvy players looking to collude will shift their efforts to areas in which enforcement is lacking.

Notwithstanding the technical challenges, it is critical that antitrust enforcement step up to the task and stay abreast of technological changes. Even the mere fact of signaling interest in enforcement can be beneficial. The fear of detection is a good weapon against cartels, and combatting the notion that blockchains are a safe haven from detection could deter at least some cartels.

Finally, strengthening whistleblowing could be enforcers’ best tool at detecting and combatting collusion via smart contracts. Those involved in or privy to the smart contracts in question could be best situated to both detect the wrongdoing and provide the required evidence to enforcers at the U.S. Department of Justice, the FTC and other government agencies. Providing financial incentives to whistleblowers to report antitrust violations is one common sense solution that has been successfully employed by other federal agencies, like the SEC and the IRS. As detection from the outside becomes increasingly difficult, facilitating detection from the inside becomes paramount.

Ultimately, when opportunities for collusion arise and enforcers are behind the curve, opportunistic firms will try to take advantage. The question is when this happens with smart contracts, will antitrust law be ready to step up to the task?

Written by Jeff Shinder and Kristian Soltes

Edited by Gary J. Malone