(Crypto)Currency===Credit, All The Rest Is Not That Important
There are many misconceptions about money and specifically credit. Some think all credit creation is bad. Others think all money should be backed by a full reserve of some valuable asset. Some think crypto tokens are not credit because someone was willing to pay for them. Others think cryptocurrencies are backed by something or have value because of the proof of work mechanism and yet many are still unaware of the credit creation process in modern banking and still believe banks are intermediaries taking deposits and lending them out.
I’ll start by explaining what I mean by money (currency) and credit and why credit is the most vital aspect of money.
When I say money I refer to the medium of exchange we use to pay for things; money is usually made out of things that are worth much less than the value they denominate (face value), such as: paper notes, copper coins, bank checks, wooden sticks (Tally Sticks), seashells, and finally digital bits either in the bank computer’s records or stored on a blockchain. All money has anti counterfeiting mechanisms but it can be duplicated endlessly by the money’s creator. Paper and digital bits are very cheap so we can print as much money as we want and create thousands of different digital coins each with an arbitrary supply.
Credit according to investopedia is: “a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at some date in the future”
Credit is the promise of a future value in which someone has agreed to pay for that promise with something of value. So what we can deduce about credit is that:
1. It’s a social tool (a contract)
2. It’s worthless on its own, and worth only as much as that promise is worth
3. It bears risk, since we know that not all promises are kept
The best example for modern credit is the ICO. A group of people with nothing but a whitepaper promise to deliver a platform in the future where it would be possible to exchange their tokens (credit) for services and products (value). Currently the tokens have no value but they are bought and paid for with something of current value: Ethereum, Bitcoin or dollars.
Some people get confused and think that the tokens are worth something or are backed by value because someone did agree to pay for them. They forget that the payment was made solely on the basis of the team’s promise and the buyer’s confidence in the team’s ability to deliver. This is in contrast to the process of asset tokenization where an existing asset of value is wrapped with a token, which can then be redeemed back to the asset on request. In the case of asset tokenization, there’s a 1–1 relation between the value of the token and the value of the asset; in the case of the ICO the asset (the platform services) are currently worth practically 0 and because there’s no relation to an asset their price is speculative and thus very volatile.
As we can see (currently) the one and only killer app of the blockchain is credit creation!
The belief in the future and the ability of people to create new value is driving a storm of innovation in the blockchain ecosystem. Like all promises many of them will fail to be fulfilled. If we take startup failure rate we can estimate that 90% of that credit will default! Wow!
So is credit creation a bad thing? Will the blockchain ecosystem go through a crisis? Or maybe because most of the ICOs were honest, and invested their money in people and products, we will have more talented teams and more available open source code that will save future projects countless work hours? Is our investment in the future worth it? Do the future teams owe anything to the initial risk takers? The speculators pumping the price? Or dumping on the market? Is this the “Laissez-faire” economy we want?
The Satoshi and maximalists’ view is that currency should have a fixed amount and can’t be created infinitely like private banking creates credit, which caused several major credit crises and an unfair distribution of wealth. While many still believe that their own platform tokens supply should be limited, just like Bitcoin, they have no problem creating credit out of thin air in the first place!
If those teams had to go to “Bitcoin VCs” to get investment (in Bitcoin) for equity would we have seen this wave of innovation? Probably not: the ability to create credit is key.
Let’s examine the philosophical and moral aspect of credit. Some believe that all money should be backed by something of value, that money should be simply a tokenized asset (such as a gold reserve). But we have so many things of value in our economy: cars, land, computers, trees and so on… if we limit ourselves to gold we fail to capitalize on most of the wealth we have. Plus there are some things that can’t be tokenized, specifically human intelligence. Human intelligence is a key factor in creating value. We can take an existing product, apply energy+intelligence, and create something new of greater value. If we can’t tokenize things like intelligence we are missing out on a whole lot of capital that is out there and isn’t being used for investments.That’s not very economically efficient.
Credit is all about trust. I trust an ICO not to inflate its credit supply in case it succeeds (because of the smart contract). But do I trust it to grow the network (platform) value in accordance with the speculative token value at the exchanges? Will it have enough funds to support the platform? Will the network economy be another victim of the tragedy of the commons? Many of these issues could be solved by self governance of issuing credits, i.e. increasing the token supply and using the newly printed currency for investments back in the platform to the benefit of all parties, users, service providers and investors (speculators). The key here is to invest the newly created credit in the real economy of the network, paying stakeholders to perform useful tasks rather than taking the credits to buy other platforms’ tokens or stocks for speculative gains.
Platforms like Sweetbridge are looking to help people tokenize everything thus enabling them to capitalize on their wealth, borrowing from themselves at 0% interest and not needing to go to the bank for costly bridge loans.
Platforms like EOS will have a yearly inflation, with the new tokens distribution being allocated by the community.
We need more token economies that issue their own credit, based on economic metrics and self governance. The problem is that we don’t have any real functioning token economies to study and if we do their token economy is set in stone (immutable smart contracts) without the ability to experiment.
Will we see more platforms like Holochain that use mutual credit systems where each individual can issue his own credit?
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