Tech Paper Q&A: The LendLedger Credit Node Part 2
Last week we released part 1 of our Credit Node centric Tech Paper Q&A. It covers questions such as “What is the Credit Node’s role on the network?” and “Why are Credit Nodes necessary?”. Now here’s part 2, further unpacking your queries as to the function of Credit Nodes within the LendLedger protocol.
Question 9: Will Credit Nodes be subject to regulation?
This is something that’s likely to vary by jurisdiction. In some jurisdictions they may be unregulated, in others they may need a money transfer license, or perhaps even other licenses.
Also good to note, LendLedger is not yet looking to facilitate cross-border payments, and so wouldn’t be subject to related regulations.
Question 10: How do you prevent fraud by the Credit Nodes?
There are a couple of points in the system where a malicious Credit Node could theoretically commit fraud and steal customers funds. First, when it takes fiat from a sender of credit (e.g. a Lender). After receiving the fiat, the Credit Node could decide not to stake LOANtokens and issue LedgerCredit to the customer. Second, when the receiver of credit (e.g. a Borrower) sends that credit back to Credit Node for fiat, the Credit Node could use the credit to unlock its staked LOANtokens, but refuse to send fiat back to the customer.
These are similar to the opportunities companies have for fraud every day (what if an Ebay seller takes your money and doesn’t send the item?), but still we take them very seriously.
We safeguard against these risks in a couple of different ways.
Reputational and Legal Safeguards:
As part of the selection criteria, Credit Nodes will be organizations with real world assets, operations and reputations they wish to safeguard. Organizations like these — whether lending institutions, financial impact organizations or fintech companies — will have the same incentive to avoid fraud as they do in the rest of their operations. It would ruin their reputation, destroy their business (not just as a Credit Node, but the rest of their business as well), and they would be subject to legal action.
Programmatic Safeguards:
Credit Nodes will be required to stake a substantial amount of assets on the system in a Performance Bond. The bond will be subject to freezing or forfeiture for fraudulent acts, and the amount of the bond will be such that the Credit Node should have far more value staked in it at any given time than they are taking in fiat from customers. Additionally, other safeguards can be created in the payment workflow, such as using strongly consistent transactions (using 2-phase commit, Percolator, Saga or similar).
Question 11: How does the Performance Bond work?
Credit Nodes will be required to stake 10% of their rolling four month credit volume. That means a Credit Node that handles $100,000 fiat per day (i.e. issues credit of $100,000) will have $10,000 x 120 days = $1.2M of LOAN tokens staked in a Performance Bond.
To create and maintain the bond, the Credit Node will stake in a time-locked smart contract an extra 10% of LOAN tokens at the time it generates LedgerCredit. So, if the Credit Node has a Lender who wants $100 in credit, the Credit Node will stake not only $100 in LOAN to generate the $100 credit for the Lender, but also another $10 in LOAN that is locked in the Performance Bond for four months.
We are still conducting research and test simulations to determine the exact amounts and structure of the Performance Bond.Some of the research we are conducting relates to edge cases, such as what happens if a Credit Node’s issuance rate increases radically in proportion to its bond. Or what if the price of LOAN decreases dramatically and the Performance Bond drops significantly in value? The key is to determine an amount and duration for the bond that is durable under more extreme conditions and gives time for detection of any fraud, while still allowing the Credit Node to conduct a profitable business.
Bond Governance
The Performance Bond will be subject to governance controls — i.e. freezing or slashing if fraud is detected. When Participants send fiat to a Credit Node, they will report that fact. That will allow the network to maintain a public and transparent record of the amount of fiat reported sent as compared to the actual amount of LedgerCredit disbursed and the amount currently in the Credit Node’s Performance Bond. We call these Performance Ratios.
Credit Nodes will be required to keep their ratios above certain minimum thresholds. If the Credit Node falls out of compliance, the bond is subject to freezing (until remedied) or slashing. Furthermore, network participants will be able to see these ratios and can make their own decisions about whether to trust and conduct business with the Credit Node based on their own tolerances.
Question 12: How does volatility in the price of LOAN tokens affect Credit Nodes?
Changes in the price of LOAN tokens can affect Credit Nodes in two important ways.
Economic Power:
First, it can change the Credit Nodes economic power in the system — i.e. the total value of LedgerCredit they can generate. As an example, if the price of LOAN were to drop in half, the Credit Node would need twice as much LOAN to facilitate the same value of lending as before. In particular, as Performance Bond sums came unlocked (after four months), they would be worth only half as much and in order to facilitate the same level of lending the Credit Node would need to have, or buy, more LOAN.
Conversely, if the price of LOAN went up, the Credit Node would end up with a surplus of LOAN relative to the same volume of lending — e.g. with a price double, they would be able to facilitate twice as much lending. The Credit Node could then elect to either hold the excess LOAN, or sell it back into the market.
The net effect of this is to stabilize LOAN prices somewhat — because Credit Nodes experience pressure to buy more when prices are low, and sell when prices are high. It also has the nice side effect for the Credit Node of incenting it to buy and sell with proper timing — as long as the Credit Node considers itself a long-term holder of the tokens.
Value of Performance Bond:
The second way LOAN prices impact Credit Nodes is to reduce the value of their Performance Bond. This matters to the network, because it can weaken the disincentive for Credit Nodes to act unethically. If the Performance Bond drops low enough in value relative to the amount of fiat the Credit Node is taking in, it might be in the Credit Node’s short-term economic (if not ethical or long-term) interest to run off with funds and forfeit their bond. However, there are a number of ways to mitigate these concerns, as detailed in the answer to question 11.
We hope you enjoyed our first Tech Paper Q&A! For a detailed look into other aspects of the technology behind the LendLedger protocol check out our Technical Paper.
