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
(http://www.moneyasdebt.net/).
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 (http://szabo.best.vwh.net/shell.html),
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,
http://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2014/qb14q1.aspx
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
http://www.positivemoney.org/,
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.
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)
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.
