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Better money

The invention of money was a direct byproduct of the need for a common medium of exchange. Humans quickly learned very early on that it was better if individuals focused on areas of relative advantage and then traded with each other rather than having everyone to do everything. For eg: If you were a forager of berries but not so good a hunter, you could still get meat by swapping your berries with someone who was a better hunter rather than risk being gored on the next sabre tooth hunt.

But as the items that needed to be exchanged multiplied, the exchange rates started getting hard to track by. Just how many chicken was one bushel of corn. And there was also the age old problem of divisibility. If your one pig was worth 100 bushel of corn and you needed only one bushel and all you had was one pig, then you could not cut it up just for that.

What was needed was a commonly accepted item that was divisible in small amounts.

Enter money.

In order for this item to be universally accepted as a medium of exchange it needed to be wanted by everyone. The obvious choice was precious items such as gold. It was shiny, it preserved itself, could be divided into small pieces and everyone wanted it.

Gold became the base unit of exchange and for a very long period of time the world economy worked perfectly fine using gold as a base. However gold has a fundamental flaw, there is only so much gold in the world.

As the economy grew, more transactions started happening which meant more and more money was needed. But the amount of gold remained fixed. As the transactions rose the demand for money or gold increased driving its price up. As gold started becoming more and more valuable people started viewing it as the asset to hold itself rather than use it to transact.

The cogs of the economy got jammed up in gold dust.

Here is the funny thing about gold. If you take a ton of gold and bury it in a cave and dig it up after one hundred years, know what you get?

Just a ton of gold (unless it was already stolen).

Gold is not a value creating asset.

If you had buried a bunch of seeds that would have created a forest, with many fruits and flowers to harvest.

Despite not being an asset that creates value, market forces led people to accumulate gold and it led to a deflationary cycle where prices of goods and services dropped as compared to gold and eventually the world hit a deep depression.

The only way to get out of the depression was to junk the free market, huge state run public works, autarky and a massive world war which doubled as a demand creating exercise of public works.

And gold as a medium of exchange had to be dropped.

Now on money would not be exchangeable for gold.

Money was now created on fiat, out of thin air by the government.

Fiat money meant that governments could create as much money as they wanted and a number of them resorted to money printing and competitive devaluations to boost their local export industry. Earlier almost every currency was translatable to gold. Which meant that a lender who had pounds could lend to someone who needed Franks as both pounds and franks were translatable to gold on fixed predetermined and well established rates.

Now it was a free for all and dynamic FX rates markets and complex hedging mechanisms emerged.

Since 2008 most countries of the world have resorted to essentially printing money on a wholesale level in order to pump in enough liquidity in the system to get the world economy going.

The disgust with such an On demand money printer is one of the reasons for the rise of Bitcoin. Bitcoin has a fixed supply and a predictable, pre-ordained release rate. Bitcoin is often compared to gold.

And while there are some fundamental differences, Bitcoin does share some characteristics with gold where it has the same challenges as a medium of exchange like gold. Hardly anyone uses Bitcoin to buy and sell anything. It is viewed as an asset in its own right meant to be held.

However one of the beauties of the Bitcoin model was the fact that it was not based on a central actor deciding of its own whim how much more money to create. It was all based on pure mathematical certainty, with no role for a arbitrary state actor to determine how much money should be under circulation.

But just because it was a digital asset based on mathematical principles does not mean it would not face the challenges associated with a fixed supply based commodity backed currency.

To counter this specific issues other cryptocurrencies arose with their own specific use case. For instance Ethereum has in theory an unlimited money supply. But it still follows a pre-ordained formula for the money release, which may not necessarily be reactive to market conditions.

In order for a currency to be better than the previous iterations of money that have come before it needs to satisfy the following criteria

  1. Is backed by a productive asset
  2. Should have an unlimited theoretical supply that adjusts dynamically to market conditions
  3. Is generated in a decentralized manner without a central authority dictating terms
  4. Allows market participants to propose their own productive assets if they do not have access to the currently accepted asset and then the wider market can determine whether or not to allow the acceptance of such a collateral

Lets elaborate on this last point a bit more.

When Germany lost world war one it the world was still on the gold standard. Germany had no gold and as it exited the gold standard for its currency, the paper marks suffered hyperinflation.

Germany then issued a new currency backed by real estate mortgages. This was a new form of collateral as opposed to gold. But the people accepted it and this currency brought the hyperinflation under control.

Germany was a nation state and could mortgage the land under its control. A start up for instance may not have any typically recognized assets such as gold or real estate. It does have the ability to provide productive services to others and there will be customers who are willing to pay for those services.

That is an asset.

Taking a step back, let us try and understand what an asset actually is.

An asset is a claim to something. It can be a claim to be the rightful owner of gold, or real estate, or property. It can be shares in a business, which represent claim to a part of the company’s ownership. It can be debt, which represents claim to be repaid a certain amount at a future debt from someone else.

Debt in turn can be of two forms.

One in which you are renting out your capital to someone else for a certain amount of time and expect it to be repaid with interest.

And the other is in which you are providing services (or goods) and expect to be paid in return. For eg: You may not have money, or gold, or real estate, but you still can go and wash dishes and make money for the provision of those services. Ideally you are engaged in a more productive endeavour than washing dishes and scaling your time, but one way or another you can be productive without necessarily having other assets to start with.

Once you provide those services you have a claim to payment.

And that claim is an asset.

You can create assets out of thin air without having other assets simply by being productive.

What is needed is a mechanism where such assets that are created by being productive can be recognized as collateral for money.

These claims to be paid are also called invoices or receivables. And there are financing services that exist where financiers issue money advance against invoices as collateral that are yet to be paid.

If we can use these invoices as collateral or the backing for money it would represent one of the best forms of decentralized money.

DAI is an algorithmically stabilized coin that is backed by Ether as collateral. However you need to have ether to borrow (or mint DAI). Other assets are on the roadmap of the Maker DAI guys and I am assuming they will be open to invoices, receivables and future cash flows as well at some point.

Allowing these invoices as collateral will allow small businesses to address their cash flow issues. The money generation will be directly linked to productive economic activity and the money supply can adjust with the increase or decrease in economic activity.

In addition a pool of uncorrelated invoices is probably a more resilient collateral than a single asset such as Ethereum. One of the fatal flaws inherent in the DAI system as it stands as of now is a potential black swan event in which the value of Ethereum drops precipitously.

Being able to address cash flow issues which almost every small business faces would be a killer application that can boost the adoption of blockchain. Imagine a business accepting crypto as payment and hence has its books basically open for review by anyone. Any receivables on the books of such a business can then be easily factored by financiers world wide at a much lower cost and at a much higher speed than the typical factoring merchants.

Right now factoring businesses only typically deal with blue chip receivables that are above a certain amount to justify the cost of diligence and risk associated with it. A defi solution around this can drastically upend the current state of affairs in favor of the businesses. This will in turn lead to lead to more business success stories and an uptick in economic activity which should lead to a virtuous circle.




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Moresh Kokane

Moresh Kokane

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