Abstract:

An important part of the criticism raised against the adoption of contract automation relates to their inflexibility. Drawing on rational choice theory, we explain why inflexibility, when seen as a constraint, can ultimately not only enhance welfare but also enable cooperation on algorithmic markets. This illuminates the need to address inflexibility of contracting algorithms in a nuanced manner, distinguishing between inflexibility as a potentially beneficial constraint on the level of transactions, and inflexibility as a set of systemic risks and changes arising in markets employing inflexible contracting algorithms. Using algorithmic trading as an example, we show how the automation of finance has brought about institutional changes. Analysing the findings through the lens of new institutional economics, we explain how a widespread adoption of contract automation requires institutional change to hedge against risks and what the emerging algorithmic contract markets can learn from algorithmic finance.