martes, 12 de mayo de 2015

What the hell is a P2P credit?

The blockchain supporting Smart Contracts opens the door for practical implementations of some dreams of the monetary reform. Now we can easily implement new currencies and many other financial instruments.
One of the most controversial financial instruments is credit. In our current world, giving credit is almost monopolized by banks, and in fact, most of the circulating money is created as a record of a debt, as a loan or as a mortgage, in a system called Fractional Reserve Banking.
The monetary reform movement explores in many alternative directions.

What is money?

Lets go back to basics. Money is supposed to solve the “double coincidence of wants” problem in a given market. Somebody puts some tickets into circulation in that market, tickets accepted by everybody as a measure of value, decoupling the problem of the “double coincidence of wants” (of products to be exchanged) into a simple coincidence of wants of a product against the number of tickets representing a value. Everybody wants the same tickets, although different goods. It is a “wishes translator” trough a common meta-wishes tool, money. Any product can be represented (for the purposes of the market) by its market value (at that market) embodied by a number of the tokens used (in that market).
In the middle age village markets it was possibly the baker the one writing tickets representing bread, to be baked later in the morning. This is the nice tale told by Paul Grignon ( That is, the “less abstract” kind of token is a token representing a commodity wanted by everybody: bread. The token does not need to represent an existing good, it can be a promise. Day after day, year after year, the baker bakes some bread. He has a well established reputation. Therefore, his tokens, a “promise” of a product, can be used as money.
States have always issued coins of legal tender money representing due taxes, and have paid their armies with them. Everybody is forced to pay taxes. Therefore the tokens representing the taxes to be paid is also a token wanted by everybody. In fact, as Nick Szabo explains (, these tokens representing tributes to be paid to the warlord appeared before a significant market worth its name existed between tribes. The “pax romana” imposed by the warlord, with its tax money, is what gave the ingredients for the market to grow. Even in the Middle ages, the bakers money was only used at the occasional free markets at the free villages. Usually, the tax money coined by the feudal lord was used.
Nowadays, banks put into circulation registries representing debts due to them.
In one way or another, money is a token that is a social instrument to solve the “double coincidence of wants” in the market, and that is accepted by everybody. Normally there are very convincing and even enforcing arguments to be accepted by everybody. But this is instrumental. If it can be accepted otherwise it will work as well.

What is credit?

Credit is also supposed to solve the “double coincidence of wants” problem in a given market, but in the time dimension. Somebody needs some money now to buy something that he wants now, and no later, but he will get the money only later when he makes another future transaction, a transaction that cannot be done now (he has an hotel, but customers only want to come later on in summer).
Credit is needed to be able to increase temporarily and locally the monetary mass with money there where it is needed. The money will arrive later (this is what solvency means) but the chain of transactions has not brought it there jet. However, the money is needed now to generate a new transaction demanded by the economy.
We all use credit cards. We buy goods with the credit card, because the salary will arrive later almost for sure. The credit card company has analyzed our solvency to set the limits. The credit card company only statistically considers that when they send the monthly bill we may have spend already all the salary. If that happens, there are clear remedies.
Without this possibility of credit the economy gets stuck. We all know, without credit most SME's would not survive. SME's are responsible for the largest part of the economy. By nature, SME's arrive at cashflow problems. Every sale only randomly adjusts to the planned cycle from offer to delivery to payment. For large corporations with huge number operations this becomes a moderated noise. SME's, with few sales in relation to total sales, need to ride the random shaking of incomes and payments in their balance sheet. The credit financial tool provides this flexibility to smooth the peaks with money out of the credit.
The credits we need should be able to be as large as necessary (depending on the solvency), have a clear payback timing and deadlines, short or long, and the outcome of a default at payback has to have a clear remedy (including, but not only, sanctions).

Credit in the Fractional Reserve Banking system

The historical role of the Fractional Reserve Banking System has been very positive, it has been a very useful financial system for the last centuries. Banks provided a service of giving loans, by creating money out of the nothing. The Fractional Reserve Banking System loan mechanism means that they are authorized to increase temporally the total monetary mass (Money creation in the modern economy, Quarterly Bulletin 2014 Q1, BANK OF ENGLAND), and thus to generate a small inflation with each credit. The banks social added value was historically to analyze the solvency of the borrower. Banks give credit but also guarantee that the overall monetary mass goes back one day to the original level, that is, that loans are being paid, so that money does not inflate forever.
This is indeed a wonderful financial invention!
In a way, in the Fractional Reserve Banking system a credit resembles the quantum effect of putting into circulation an electron and a hole at a semiconductor. Once an electron is dispatched, the electron can travel separatedly from the hole. So can do the money and the debt of a credit.
Credit is a kind of tunnel effect. Money can emerge because it comes across a time barrier instead of an energy barrier. The money was supposed to appear later as a result of a transaction of real goods, but it appears now. To do so, there be a hole. When the real money appears, the hole, the debt, may have also gone elsewhere. So, there real money looks for another hole to fuse and disappear in the nirvana.
For the system to work, the monetary mass has to stay in average the same, meaning that every electron has to find sooner or later a hole, and every credit has to find a coin representing a real good.
Unfortunately, at giving credits, banks have become a fiasco when analyzing the creditworthiness, the solvency, of the creditors. Instead, the bank speculators have demonstrated to act as compulsive gamblers playing bingo and baccarat with the real world. At the top of the financial pyramid, in the economy of the XXI there is no anymore benefit left than for bubbles. Solvency does not play any role any more.
In my view, the essence of the discussion of monetary reform is the discussion about who analyses the creditworthiness of the creditor in any credit system, clearinghouse, or currency invention, under the condition that we radically democratize that function, so that we are back to solvency at giving credits.

What is P2P in a P2P credit?

A P2P credit is not necessarily P2P in the sense that we transfer saved currency assets from one or several moneylender Peers to a borrower Peer. This we call crowd-funding. Crowd-funding cannot be generalized, it would require a too high level of savings by all members of a Community. This would again reinforce the role of money as storage of value, a role we would like to decrease.
What becomes P2P is the solvency analysis of the borrower. Any or several Peers, with reputation enough, are entitled to give their judgement of the solvency of the Peer borrower. The same way the expert of the local branch of your bank in the Fractional Reserve Banking System does now. If their assessment is positive, the Community will just create out of the nothing, as banks do, the money necessary for the credit.
Once the money is given back, it is destroyed, so that the monetary mass returns to the equilibrium of:
M x V = P x Q
If the borrower returns the money on time, the reputation of the “moneylenders” is increased. If not, the reputation of the “moneylenders” is penalized, and probably they get a penalty in money as well.

An example

Susan has a business of renting rooms at a winter ski station. Bob has made a reservation for two rooms at T3, January next year, at the price of 2 Units of Account, and Mary has made a reservation of one room, at the price of 1 Unit of Account, also for T3, January next year. Susan has checked, at the moment of the reservation, T1, in June, that Bob and Mary earn enough. Nevertheless, you can never be sure that they will not cancel the reservation in the last minute. In that case, Susan will need to urgently see for another customer. So far, over the last years she succeeded to have full booking.
Susan would like to engage in a course of hotel management provided by Charlie that starts at T2, September. The price is 3 Units of Account, and has to be paid at T2.
Susan would need a credit from September to January of 3 Units of Account. The P2P Community just creates the money out of the nothing, annotates the debt in a credit account, and increases her currency account by 3 Units of Account (later we will propose a slightly different mechanics). 
To do this procedure, the P2P Community delegates to some “moneylendering” experts the analysis of Susan solvency. 
At a P2P Community, this function can be radically democratized, but not automated. Of course, some past records and generic analysis of Susan finances can be provided by some smart automated programs, but nothing will replace the concrete analysis of the concrete credit needed for a particular situation, made by a human. Except for the generic credit given by credit cards for a limited amount, this is how most credits, in special credits for SME's, work. Its a human at the local branch of the bank who will do the assessment.
In fact, we can give upfront to any member a given “credit card” type of limited credit. Most LETs and Time Banks do so.
Beyond that, we can give more ad hoc credit, and any Peer in the Community that knows Susan and wants to do the service of solvency analysis could do it. He or she has only to accumulate enough “moneylendering” reputation. We could arbitrarily say that anybody starts with a given amount of “moneylendering” reputation, and anybody can give credit for a quantity and a time in which:
quantity x time < reputation
In case of need, Susan may add the reputation of several experts.
Contrary to solvency, the calculation of “moneylender reputation” can be easily automated and hammered in stone in the blockchain, so that nobody can cheat it. You just increase the reputation by some agreed function on any properly returned credit, and penalize it equally by some agreed function on the amount and time of unpaid due quantities of the credits he or she assessed.
Of course, the service should be paid. But it is not essential to embed this service payment in the system. Rather, we can leave it to the market, and negotiated out of the credit contract as such. Therefore, the payment of “moneylender” services have not to be designed together with the credit system.
We all could assess a credit in good faith. But because the reputation can accumulate, some members of the P2P Community may chose to make a living out of it and become “professionals”. Fair enough. They will care to stay in business by not letting their reputation be penalized.

Credit mechanics is different to a mortgage

In order to avoid misunderstandings as we progress designing the P2P functions, lets clarify first that credit is not a mortgage over a long lasting good, like a house, in which the good can be the collateral (the easy solvency case). A credit has usually no clear or specific collateral.
Mortgages, in which the mortgages assets are the collateral, are no longer needed in a monetary system where most currencies represent a promise of a good. Some other money is fiat public tender money representing the commons public works: the public servants works, services and goods. Money, in this case, is a promise of public goods.
In such a system, buying property, real estate or long lasting machinery or goods can be done without credit. It can become a barter system between the producers of long lasting goods and the producers of every day consumption goods or services. In the end the producers of long lasting goods need to eat fresh food every day. Buying property, real estate or long lasting machinery or goods consists in an exchange of the currencies with a long extinction time (i.e. representing a production a batch of bricks) and currencies with a short extinction time (i.e. representing a production of a batch of yogurts).
There is no credit. There is an exchange of bonds in the currency exchange market.

Credit is not an investment

Further, lets discard another potential misunderstanding. Investment is not a credit. At an investment, the investor shares all the risk of the investment. If the capital is lost, the investor loses the capital.
At a credit, the law obliges the borrower to give back the money in all cases.

The monetary reform proposals

In most cases, the monetary reform proposals (like the sovereign money proposal by positivemoney, most P2P credit proposals) suggest that credit is done by transferring money stuck in a saving.
It is doubtful that the volume, the speed and the flexibility of the credit required by the economy, in special, the needs of the SMEs, can be covered by the amounts available as savings in the banks or any future trusted recording system. In fact, now, only around 1% of the money is backed by deposits. The rest is credit money. Are we planning to shrink credit by 99%?
Moreover, this system has a strong centralizing force, since we are introducing again a “double coincidence of wants” problem, to match somebody lending a certain quantity of money for a period of time with somebody needing it exactly for that period. Only large entities like banks, disposing over a vast amount of deposits can treat it making the moneylender anonymous over average saving levels.
Paul Grignon solves the issue by proposing that all the money is self credit of the main industrial providers of basic goods. This solves the problem of some part of the credit used today, the one used to finance these large industries, but not all. If a currency called “vegetables” is backed by a promise of agricultural goods, who else than the agricultural industry can give credits on this currency? What does it mean, a credit of “vegetables”? Who will analyze the small Susan case?
Saving is itself a problematic function for money. Money as a storage of value is already questioned by many monetary analysts. Indeed, some equilibrium can be reached in the formula with a steady flow of savings:
M x V = P x Q
(M – savings + back from savings) x V = P x Q
We are talking about decisions on savings today, to work in the formula 10 or 20 years from now, and money back in circulation coming from savings 10 or 20 years ago. Has this any meaning in real economy if savings is not linked to lending with interest?
You can put money in a socked under the mattress. But the perishable goods they were supposed to pay for will not take the time machine to reappear in the future when you want to buy them. The relation of savings to real economy is anything but straightforward.
As said, in an economy where credits have no interest, and currencies represent goods or public services, accumulation (“savings”) can best be done by acquiring currencies representing long lasting goods (i.e. marmor), goods that will really be produced.

Cheating the system?

Some background noise of cheating in the system can be expected, possibly by beginners, until they learn the consequences.
Say you act as cheating moneylender and assess a credit to a friend without solvency. Your reputation as moneylender is ruined and your friend will have his account blocked until sufficient income comes in to cover the debt.
The quantity of this cheating operation is limited to the initial average reputation of the moneylender, which is low.
Imagine the cheating moneylender patiently accumulates reputation by giving properly assessed credits waiting for the last operation, which is fake. Then they disappear in some Caribean island with the money of the last credit.
Remind that assessing credits is not anonymous. At every credit, there is an extra-monetary personal relation with the borrower to explain the particular financial case. By the time the moneylender has accumulated enough reputation to plan a last credit to fly to the Caribe, many other members of the Community know the real person by hard and can be easily prosecuted by whatever authorities. There is nothing like cyber anonymity in the procedure, although it can work with anonymous accounts.

How to design a currency with P2P credit on ethereum

The design of a currency with P2P credit on ethereum would imply three contracts, one an almost standard currency contract, and two quasi currencies.
(what follows is not formal programming language)
A) One contract holds the records of the currency to operate the market, holding the Unit of Account used for payments.
As in any currency, a payment or a transfer is done conditionally to the availability of funds:

  • if payer account > transfer
    • payer account = payer account – transfer
    • payee account = payee account + transfer
    • else stop

We now add the available credit of the payer

  • if payer account > transfer + payer credit
    • payer account = payer account – transfer
    • payee account = payee account + transfer
    • else stop
  • else stop

payer credit” has to be looked at and managed at a different contract, the credit contract.
Notice that the payer account can become negative.
The day after the credit expires (the deadline to pay back), payer credit becomes zero, and the payer will not be able to make any further payments until sufficient income makes the account balance positive.
B) A credit contract holds the records of the available credit for each payer.
A moneylender can add credit out of his reputation.
reputation” has to be looked at and managed at a different contract, the reputation contract.
It has a time component.

  • if moneylender reputation > credit
    • While time < deadline
      • moneylender reputation = moneylender reputation – credit
      • payer credit = payer credit + credit

When time is over, we return the credit to zero. To restore the reputation of the moneylender, we need to look at the payer account. If it is negative, the credit has not been restored, and the moneylender is penalized. If it is positive, the credit has been restored, and the moneylender is being rewarded.

    • When time > deadline
      • payer credit = payer credit – credit
      • if payer account > 0
        • moneylender reputation = moneylender reputation + credit + reward
      • else moneylender reputation = moneylender reputation – penalty
      • deadline = never (we do not repeat this)
The mechanics of the moneylender reputation reward is slightly more complicated when there are several overlapping credits with different deadlines. 
C) A reputation contract holds the records of the reputation for each moneylender. To initialize everybodys reputation with something, we can put in the credit contract the following:
  • if moneylender reputation + newcomer bond > credit
The penalty has to be at least equal to the newcomer bond.
Penalty and reward can be any agreed formula based on the amount and time of the credit.