The Credit Protocol Manifesto
Recently, BlockMason unveiled our newest product: The Credit Protocol. While you can read our Whitepaper for technical details about how the Credit Protocol (CP) functions, this article examines the product’s implications. You can learn more about our upcoming token sale here.
On the surface, the CP is a simple mechanism for recording debts and credits on the blockchain. While this is intuitively useful — after all, people interact with debts and credits on a daily basis, from covering a friend’s coffee to repaying school loans — the question remains: why would someone want to record debt on the blockchain instead of just paying in BTC or ETH or (*shudder*) fiat?
Answering this question requires a firm understanding of what separates credit from cash.
The most important difference between credit and cash is time.
Cash can only be used to settle transactions instantaneously. Debts and credits allow parties to coordinate financial transactions in advance of payment, which enables an entirely new type of financial transaction previously impossible in the world of cryptocurrency. Users can make purchases before they have the necessary capital, or when they don’t want to deploy the capital they own (for example, if it is tied up in an investment — like when you’re hodling your Ethereum until it goes to the moon).
So, why is this useful?
On a macro level, debt is an incredibly valuable tool for stimulating economic growth. Debt powers the development of virtually all large-scale infrastructure projects, like bridges and skyscrapers, as well as substantial personal purchases, like homes and cars. It is difficult for any party to assemble the necessary capital to pay for such a purchase immediately in cash, but deferred payments make the completion of such projects manageable. As the cryptocurrency economy grows, and blockchain usage expands beyond the world of finance, recording and managing debt will become essential to the expansion of the digital economy. The ability to take loans in BTC or ETH enables companies and individuals to finance projects beyond their current means in a currency that transcends local jurisdictional regulation or institutional manipulation from banks or governments.
Deferred payment on the blockchain is also an extremely useful tool for daily life. Let’s say, Tim needs to buy groceries, but he doesn’t get paid until Friday. Jesse loans him twenty dollars with the expectation of repayment at the end of the week. Recording their debt on the blockchain grants the security of an official contract hitherto unachievable for such small sums. Without recording debts, it is easy for parties to take advantage of one another, which is why people so value trust institutions like banks, governments, and lawyers. The blockchain ledger, however, can be referenced by both parties for confirmation of their agreement, allowing Jesse to loan Tim money without fear of deceit, as long as he believes Tim has sufficient incentive to repay him. If Tim never repays Jesse, Jesse knows never to lend Tim money — he has a constant reminder on the blockchain.
Additionally, because the CP is open source and allows developers to integrate their own applications on top of the protocol, it is extremely likely that these types of small payments will lead to the development of digital payment profiles and blockchain credit scores. Just as it’s tough to get an Uber ride when your rating is low, if you can’t be trusted for repayment, everyone utilizing the CP will know.
Before the CP, such financial transactions based on debt and credit were impossible to securely execute for vast swaths of the world. For the majority of the world’s population, unable to access traditional banking or payment applications like Venmo, digital currency is far more liquid and secure than cash. It is difficult to steal or manipulate, and the data storage function of the Ethereum network allows for the creation of memos about how parties agree a debt or payment should be structured. Therefore, the Credit Protocol offers a simple and secure way for users to develop lines of credit for any variety of financial interactions without banks, loan sharks, or exploitative institutions like those dealing in payday loans. For the first time, the creation of credit belongs to the people.
Another important difference between credit and cash is the notion of agreement.
Trust is essential to the extension of credit. In order for a lending system to work well, the lender must be confident that his or her debt will be repaid. The parties must also agree upon the method and amount of repayment, especially if the debt is not recorded in traditional forms of currency — a very powerful use-case enabled by the CP.
It is for this reason that credits and debts recorded on the CP utilize double confirmation as a de facto trust mechanism. By recording a transactional agreement in the immutable blockchain ledger, it mimics the power of government-backed legal tender or physical assets like precious metals. To elaborate, if two parties are exchanging goods and services for cash or physical assets, the denomination of currency or amount of that asset stands in as an agreement of value because society as a whole supports the redemption of such currency for a (relatively) stable amount. Debts and credits, however, allow for the creation of economic systems in which the currency is arbitrary, as long as it is redeemable for an agreed upon value — for example a school that distributes meal tokens to its students. Hence, the power of double confirmation — the value of the currency is created when both parties agree to its exchange, and the very act of agreement can generate new currency.
Often, these debts and credits function best in a closed system, in which the new currency must be guaranteed by its issuer. For example, in the United States, we accept USD because we believe we can redeem our cash for goods and services — in part because the government itself will take USD as payment (in the form of taxes). We don’t accept Thai Baht because the government will not accept it, and therefore we don’t believe we can redeem it for value.
This is true for systems both large and small, and is particularly powerful for systems in which large institutions or companies owe debts to individuals. These debts can take many forms: retail gift cards, loyalty reward programs like airline miles, or an internal payment system in a university or corporate campus. What is necessary for these debts and credits to function is agreement between parties about for what the currency — be they miles, gift cards, or University of Kentucky Wildcat Dollars — can be redeemed. As long as the issuer of the currency accepts it for payment, the currency has value. Additionally, failing to accept the currency one issues has significant social and economic consequences, as the institution can lose their authority, trust, and customers.
To illustrate this concept, let’s examine a simple closed economy: a mother promises to buy her children a toy if they complete their chores. In physical form, this system may be represented by a “Star Chart” to record chore completion, but using the CP, we will imagine a new currency created called Mommy Dollars. The smart contract built atop CP says that for each chore completed (and acknowledged by both parties), a new Mommy Dollar is generated and sent to the child. Additionally, the contract stipulates the child may exchange 10 Mommy Dollars for one dinosaur action figure. When the child has 10 Mommy Dollars, he redeems his tokens for an action figure in real life, and both the mother and child confirm that the debt has been settled.
In this way, the CP actually democratizes the creation of both credit and currency. This is distinct from the creation of tokens on the Ethereum network, because credit and closed-loop currencies require formal agreement between parties on the methods of redemption.
It is not an exaggeration to say that the potential uses of the CP are near limitless. BlockMason’s Credit Protocol has given institutions and individuals power that previously only existed in governments and central banks: the ability to issue credit and create currency. While we will continue to publicly explore the possibilities of the CP, here are just a few examples of exciting applications enabled by the protocol.
- Social debt tracking among networks of friends (actually, our very first application on the CP: Friend in Debt, which we will release in the coming week).
- Gift cards issued by retailers
- Closed economy currencies for campuses, companies, or attractions.
- Loyalty rewards programs for frequent customers.
- Crowdfunding medical expenses through microdebts.
- Infrastructure and construction loans for large project development.
- Personal digital banking in areas without access to traditional banks.
- Small consumer loans between trusted parties enforced through digital asset collateral or linked to blockchain reputation systems.