CIDRD Working Group                                Paul Resnick
Internet Draft                                             AT&T
                                              February 22, 1996


  Suggestions for Market-Based Allocation of IP Address Blocks
              <draft-ietf-cidrd-mktbased-alloc-00.txt>

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ABSTRACT

Market-based allocation of the existing 32-bit address space will
offer several advantages as unallocated space becomes scarce. Most
importantly, addresses will be allocated to those who value them
most. In addition, address allocations will adjust more quickly to
changes in network topology or utilization efficiency. A registry
will still be required, much like a registry of deeds for real
estate, but the registry would no longer make allocation
decisions.

. ADDRESS ALLOCATION TODAY

The 32-bit address space used in IPV4 has been and continues to be
allocated through an administrative process. Internet Service
Providers and other organizations submit applications to the
InterNIC or a delegated registry such as RIPE. The main criterion
for accepting or rejecting an application is efficient utilization
of the requested block [1]. The registries take great care not to
assign the same address to two different organizations. The
Internet Service Providers may in turn delegate number assignments
to customers. Occasionally, ISPs go out of business or
organizations stop using certain address blocks and voluntarily
return them to a registry for reassignment.

Assignees do not pay for the numbers they receive. The InterNIC
itself is subsidized by the NSF. This panel is supposed to propose
methods of making the InterNIC self-supporting. I propose to
remove one of the functions of the InterNIC registration services
to a free market, leaving a much restricted function that will be
less costly to run.

. WHAT'S WRONG?

One weakness of the existing procedure is that there are no
incentives to return address blocks for reassignment to other
organizations that may be able to make better use of them. Over
time, an organization's needs may change and the address block may
become underutilized. The network topology may also change, so
that routing would be far more efficient if an address block were
reassigned. A convincing argument for the need to adjust address
allocations over time appears in [2].

A second weakness will surface as the address space becomes
scarce. Approximately half of the addresses have been assigned so
far, with the exact amount depending on one's definition of
assignment
(ftp://ds.internic.net/netinfo/ip_network_allocations.95Nov).
Extrapolations from current trends indicate that the space will
last until sometime in the next decade (ref. Tony Li's graphs.) As
the unassigned space becomes scarcer, the evaluation criteria for
new requests are likely to become stricter.  The registries will
come under increasing pressures from commercial interests,
political lobbying groups, and governments. Caving in to these
pressures will result in sub-optimal allocations while resisting
them may be a Herculean task. Running the registries in those
circumstances will be neither cheap nor fun, though it may be
profitable if corruption creeps into the system.

. POTENTIAL SOLUTIONS

One obvious way out of this impending predicament is to alleviate
the scarcity, and several technical approaches are in the works.
First, CIDR permits registries to tailor the size of an allocation
more closely to the number of hosts that will be connected. Prior
to CIDR, organizations that needed more than a single class C were
routinely allocated an entire class B. Now, an organization can be
assigned four class Cs that form a CIDR /22 for routing purposes.
Second, some organizations are using designated IP addresses that
are not globally unique, so that they do not need to request a
globally unique allocation for all their internal computers [3].
Finally, IPV6 will introduce longer addresses, yielding a much
larger address space [4]. Still, the prospect of IPV4 address
scarcity is quite real, as indicated by the registries ongoing
policies of conserving space for potential future requests.

If scarcity cannot be eliminated, allocation decisions should be
moved out of the political realm and into the economic realm,
which can handle scarcity more gracefully. If we want to maximize
social utility, addresses should be assigned to those who derive
the most value from them. Some organizations will value addresses
more than others and organizations will value particular address
blocks differently, due to routing considerations and due to the
costs of renumbering away from addresses currently in use.

. TRANSFERABLE OWNERSHIP

No system of central planning will be able to take into account
all the local variations necessary to optimally allocate (and
reallocate) addresses. Instead, we should empower local decision
making. The Internet community has already taken one step in that
direction, by permitting ISPs to delegate numbers that have been
assigned to them. We should continue along that path by allowing
and encouraging ISPs to exchange entire large blocks with each
other.

The simplest method is to invest ISPs and other organizations with
a limited set of property rights over addresses. In particular,
two rights would come with ownership of an address:

. Exclusive use. No one else is permitted to advertise that
address for routing purposes on the public Internet.

. Right of transfer. At the organization's discretion, it can
transfer the first right to another organization, in return for
whatever compensation, including monetary compensation, that it
is able to negotiate. Organizations may also temporarily
transfer rights, in the form of a lease [2].

An Internet-wide registry of deeds would still be required, to
resolve ownership disputes. This would be a slightly different
function than that served by today's InterNIC. The registry would
not serve any allocation function: it would not review
applications and assign blocks. The registry would merely record
each transfer of property rights. This registry should be less
expensive to run than the existing InterNIC registration service,
and could be accomplished purely by computer. It may also be
possible to distribute this service, permitting multiple
registries of deeds to share a common database. These registries
could then be offered on a pay-for-service basis, and compete with
each other on price or quality of service.

. ROUTING IMPLICATIONS

Note that there is no "right to routing" that comes with address
ownership. Others are prevented from using the address for routing
on the public Internet, but the address owner may need to make
separate arrangements to ensure that traffic destined for that
address is routed properly to a machine that it chooses. In
particular, some ISPs may only route for large aggregate address
blocks, so that ownership of a single IP address may not be very
valuable. It may be more valuable to own a single /18 than to own
 separate /24 addresses because almost everyone is currently
willing to include a /18 in router tables. That means that an
organization can switch ISPs and still continue to use the same
/18 address block.

The idea of charging for router table entries or BGP traffic has
been floating around the IETF community for a while and is now
receiving serious consideration in the cidr working group. Such
charging mechanisms could mesh well with this proposal. Given
current technologies, we have to make tradeoffs among the worthy
goals of small router tables, route optimization, efficient
address space utilization, and address portability. Since the
costs of renumbering or of suboptimal routes vary between
organizations, separate charges for addresses and for routing will
provide incentives for organizations to make appropriate
tradeoffs. In fact, it may be that neither charging mechanism will
work well without the other: mixing market-based decisions with
administrative ones may lead to sub-optimal decisions in both
address allocation and routing.

One effect of routing charges will be to create a premium price
for large address blocks, which has a couple of implications.
First, most of the market participants are likely to be large
organizations and ISPs. Most small customers will continue to
purchase a service from ISPs that combines lease of addresses with
routing privileges. Second, there are likely to be ISPs (or even
speculators) who purchase specific blocks to complete larger CIDR
blocks.  This is analogous to lot assembly for large building
construction. The assembly service is valuable to the Internet as
a whole, because it simplifies routing, and the premium price for
larger blocks will offer appropriate incentives to those who
perform it.

. INITIAL ALLOCATION

If we are to switch to a system of transferable property rights,
the question naturally arises of who should own the addresses
initially. Many would argue that all the addresses are currently
owned by the community as a whole, and merely loaned to their
current assignees. Others would argue that the current assignees
should be granted ownership. In any case, there are unallocated
and unassigned addresses and some organization would need to be
given initial ownership of them.

Decisions about who initially gets property rights to addresses
will impact wealth distribution, especially if addresses become
scarce and trade at high prices. Those who obtain large initial
property rights may enjoy a windfall. Fortunately, however, the
initial allocation should have little impact on whether an optimal
allocation is achieved. In a famous paper, Coase pointed out that
as long as exchanges are easily arranged, property will eventually
end up in the hands of those who value it most, regardless of who
owns it initially [5]. If the government of Burundi receives a
large initial allocation but has few computers it wishes to attach
to the Internet, it should sell or lease the addresses to someone
who can make better use of them. Fairness and social justice,
then, should be the primary criteria for deciding initial
allocation of property rights.

As the least disruptive option, I suggest that property rights be
given to current assignees. It would be up to ISPs to negotiate
with their customers over ownership of the addresses they have
reassigned in the past or reassign in the future. IANA or other
bodies may choose to retain ownership of some blocks. The
remaining unassigned blocks would be auctioned off, just as the
U.S. FCC recently auctioned off spectrum for wireless
communication. That auction should be designed carefully, but I do
not address its design in this paper. Then there is the problem of
who gets the proceeds from the auction. Some might be retained by
a body such as the Internet Society or the IETF for future use
that benefits the entire network. If the proceeds are very large,
it may be appropriate to donate them to some international
organization.

. ELECTRONIC MARKET ADVANTAGES

To encourage transfers of ownership whenever such transfers are
mutually beneficial, it may be desirable to form new market-making
institutions. The market will enable interested buyers and sellers
to find each other. It can also help in what economists call
"price discovery," the identification of a common market price for
similar goods.

Price discovery is useful for two reasons. First, for those in the
market, a well known "going price" avoids the need for bilateral
negotiations. A well-known theorem in economics [6] argues that,
when neither buyer or seller is sure how much an item is worth to
the other party, there is no very good price setting mechanism.
Either the buyer will bid lower than his true value or the seller
will demand more than her true value, and usually both. Not only
is much energy wasted, but skillful negotiators will sometimes
miss a mutually beneficial exchange because they are jockeying to
get the best price.

Price discovery is also useful for those not in the market. A
well-known "going price" permits other organizations to decide
whether or not to enter the market, and to plan for the future. In
the case of IP address blocks, it will provide useful signals
about how much should be invested in technologies that alleviate
scarcity. For example, if IP address blocks are selling for a high
price, there will be an incentive for the creation of renumbering
tools, so that organizations that are underutilizing their address
blocks will be able to consolidate cheaply and sell off some of
their blocks. High address prices may also hasten the deployment
of IPV6.

It is possible to introduce price-based incentives into the
administrative allocation process without turning completely to
market based allocation. Registries could lease address blocks for
a fee, as suggested in [7]. Such an approach, however, misses the
opportunity for price discovery. Unless the registries conduct
auctions for leases, they will not know the optimal prices to set
and hence the self-selections that ISPs make based on those prices
will not lead to an optimal allocation.

. MARKET DESIGN GOALS

The market-maker that facilitates exchanges can be a private party
not affiliated with the InterNIC. There can be competition among
market-makers, based on the cost of transactions, speed, and other
factors. The primary goal of anyone designing such a market should
be facilitate all and only those exchanges that are mutually
beneficial.

An area of theoretical economics devoted to designing such markets
is called "mechanism design." A mechanism is a set of rules for
submitting bids and offers and for resolving those bids to match
buyers and sellers and determine prices. If the buyers honestly
reveal the maximum price they are willing to pay and the sellers
honestly reveal the minimum price they will accept, it is
straightforward to arrange an optimal set of exchanges. The
problem is that the rules for determining prices may give buyers
and sellers incentives to make bids that do not reflect their true
values.

One well-known mechanism that does encourage honest revelation is
called a second-price auction. It can be used when there are many
buyers, but just one seller selling a single product. Each buyer
seals a bid in an envelope. All bids are opened simultaneously.
The highest bidder gets the product, but pays a price equal to the
second highest bid. The amount of your bid determines whether you
will win the auction, but has no impact on the price you'll pay,
so there is no point in bidding anything other than your true
value.

The market for IP addresses may be slightly more complicated.
There are many possible address block sizes for sale and there are
complementarities among blocks. As suggested above, a set of 16
contiguous class C addresses that can be assembled into a single
/20 CIDR block will likely sell for more than 16 scattered class C
addresses. Thus, the mechanism choice for an IP address market
will be an interesting research problem for economists and network
engineers to solve together.

. POTENTIAL MARKET FAILURES

The arguments above have assumed a somewhat idealized situation of
a perfectly functioning market. Market participants are
knowledgeable, transaction costs are negligible, there is no abuse
of market power, there are no externalities, and equity concerns
can be separated from efficiency concerns. In reality, these
assumptions may be violated to a greater or lesser extent.

First, if market participants are not knowledgeable, they may make
suboptimal decisions for themselves. The government of Burundi may
sell its initial allocation of addresses at a low price, not
realizing that in a few years it will want those addresses.
Organizations that do not understand the importance of route
aggregation may buy small address blocks on the open market and
then find that ISPs will not route traffic to those addresses. In
such situations, the registries may be better at determining the
value of address blocks to individual organizations than those
organizations are. If, however, the market is mostly for trading
among large organizations and ISPs, it is reasonable to expect
them to understand their particular circumstances better than any
central administrative authority will.

Second, if transaction costs are high, such as the cost of
negotiating a price or registering a transfer with the registry of
deeds, suboptimal allocations are likely to continue. There is no
reason, however, for these costs to be high. Note that renumbering
costs should not be viewed as transaction costs: if an
organization uses an address block sparsely but has high
renumbering costs, its actual value for the address block may be
quite high, and it may be optimal for that organization to
continue using the addresses sparsely.

Third, there may be a concentration of market power. Geoff
Huston's analysis of address allocation is similar to that
presented here, but he views market-based exchange as something to
be avoided, because ISPs might act as an oligopoly to erect
barriers to entry for newcomers [7]. As the number of competitors
increases, however, they are more likely to compete than to
collude. A related problem is the possibility of speculators
acquiring large numbers of addresses and keeping them off the
market in an attempt to create artificial scarcity that drives up
prices. Cornering the market in this way is a difficult strategy
to implement, but it is a real danger to the community. The market
may need to be governed by securities exchange laws such as those
that govern the U.S. securities and commodities markets.
Alternatively, since "ownership" exists only by mutual agreement
of other parties, perhaps the IANA or the ISPs would retain the
right to confiscate and reallocate addresses that are withheld
from the market in an attempt to drive up prices artificially.

Fourth, there are wealth distribution questions. Suppose that a
university in Thailand is willing to spend $100 for a block of
addresses, but a large company is willing to spend $500 for those
addresses, to be used for profit-making purposes. It is tempting
to say that willingness-to-pay is a poor measure of which use is
more valuable, especially if the university has less wealth to
spend. Questions of wealth distribution and equity, however,
should not be confused with allocative efficiency. For example,
suppose the Thai university acquires the addresses for $100. If
permitted to do so, it will resell them for $500 spend the money
on something it thinks is more valuable. This amounts to a $400
wealth transfer to the university, but has no effect on the
allocation of addresses. If resale is not permitted, on the other
hand, the university keeps the addresses, but there is a
deadweight loss: both the university and the potential purchaser
would be better off if the resale were permitted.

Finally, there may be positive externalities that individuals will
not take into account when allocating through the market. Each new
addition to the Internet creates a benefit for everyone who is
already connected, because they have someone else to share
information with. This argument is often used to justify subsidy
of telephone service for high-cost and low-income subscribers, in
order to generate universal or near-universal service. Unlike the
wealth distribution argument, this one may justify subsidizing
addresses for the Thai University: connecting a university from an
under-represented region may create larger externalities for the
rest of the Internet community than would connection of another
commercial organization. A separate fund may be needed to
subsidize connections from less represented regions, so that we
can all benefit from worldwide connectivity. This fund might be
modeled on the one proposed by Eli Noam for funding universal
telephone service in a competitive environment [8]. Money
collected from the initial auction of addresses might also be used
for this purpose.

. SUMMARY

The essence of this proposal is to make address assignments
transferable and condone the practice of money changing hands as
part of such transfers. The best way to make use of an address
block depends on how valuable it is to attach various devices to
the Internet, on routing considerations, and on the costs of
renumbering. By devolving authority to those who are intimately
acquainted with these costs and benefits, better decisions can be
made. By introducing money into the mix, parties will have the
incentives to make those better decisions. This proposal would
complement a proposal to introduce incentives for route
aggregation. Rather than fighting the profit motive, the Internet
community should harness it to give individuals and organizations
incentives to act in ways that improve resource use.

Taking allocation decisions out of the hands of the administrative
body will reduce its workload, and avoid many of the headaches
that would arise if administrative allocation procedures continue
into an era of scarcity. The registration function would be
reduced to simply keeping accurate records of the current
ownership of address blocks.

One new coordinating function will be required, that of market
maker. This function need not be officially sanctioned, however,
and several organizations can provide competitive services. An
important design goal for the market makers is to set up an
environment in which honest revelation is the best strategy, so
that all the profitable exchanges can be arranged.

. REFERENCES

        []     E. Gerich, "Guidelines for Management of IP Address Space,"
        Merit RFC 1466, October 1992.

        []     Y. Rekhter and T. Li, "Implications of  Various Address
        Allocation Policies for Internet Routing," Cisco, Internet Draft
        draft-ietf-cidrd-addr-ownership-07.txt, January 1996.

        []     Y. Rekhter, R. G. Moskowitz, D. Karrenberg, and G. J. de
        Groot, "Address Allocation for Private Internets," IBM, Chrysler,
        RIPE, RIPE RFC 1597, updated by ID draft-ietf-cidrd-private-addr-
        05.txt, March 1994.

        []     S. Bradner and A. Mankin, "The Recommendation for the IP
        Next Generation Protocol," Harvard, ISI RFC 1752, January 1995.

        []     R. Coase, "The Problem of Social Cost," Journal of Law and
        Economics, vol. 3, pp. 1-44, 1960.

        []     R. Myerson and M. Satterthwaite, "Efficient Mechanisms for
        Bilateral Trade," Journal of Economic Theory, vol. 28, pp. 265-
        281, 1983.

        []     G. Huston, "Management of Internet Address Space," AARNet
        RFC 1744, December 1994.

        []     E. Noam, "Beyond liberaltion III: Reforming universal
        service," Telecommunications Policy, vol. 18, pp. 687-704, 1994.

. SECURITY CONSIDERATIONS

Security issues are not discussed in this memo.

. ACKNOWLEDGMENTS

Thanks to Steve Bellovin for pushing me to write up these thoughts,
and for thinking through the impact of CIDR and route aggregation on
the value of address blocks. Thanks to Giuseppe Lopomo, Chris Avery, and
Richard Zeckhauser for information about market mechanisms. Thanks to
Noel Chiappa for comments on an earlier draft, and to Caroline
Richardson and the participants in the CIX Workshop on Internet
Administrative Infrastructure for forcing me to think through the
possible modes of market failure.

. AUTHOR'S ADDRESS

Paul Resnick
AT&T Research
 Mountain Ave.
Murray Hill, NJ 07974-0636
Phone: (908) 582-5370
Fax: (908) 582-4113
Email: presnick@research.att.com