Tech Paper Q&A: The LendLedger Credit Node Part 1

Credit Nodes are an important part of the LendLedger network. They play a number of key roles in securing the network and facilitating the lending process. In our Technical Paper, we describe the Credit Nodes’ functions, but given its importance, the role of the Credit Nodes has rightfully prompted more questions from the community than any other single part of the project.

Here is part one of our answers to the most popular questions. As we indicate below, there are some areas where more research is indicated, and so we look forward to your continued input and feedback on these issues.

Question 1: What is the Credit Node’s role on the network?

Enabling Movement of Funds

The Credit Node’s most important job is to enable the movement of funds across the network in an immutably recorded and verifiable way.

For transactions to be trusted, it’s not sufficient for parties to report them to the blockchain. Parties might disagree: a Lender could report disbursing $100 to a Borrower, but the Borrower only acknowledge receiving $90. Transactions must therefore take place *across* the blockchain. To do this, we track the movement of funds on the blockchain using LedgerCredit — an internal unit of accounting — and use Credit Nodes to enable transactions.

In concrete terms, if a participant on the network wishes to send money to another party, they must work with a Credit Node. First, they deposit fiat currency (e.g. USD) with the Credit Node and receive back a credit on the system for that amount. Then, they can send this credit (the LedgerCredit) to another party in a transaction. Because the transactions happen over the blockchain, they are immutably recorded and verifiable. Recipients of the credit (LedgerCredit) can then return it to the issuing Credit Node in exchange for the fiat currency the credit represents.

Verifying Lenders

Credit Nodes also ensure only legitimate Lenders operate on the network. To join the network, Lenders must register with a Credit Node. That Credit Node is tasked with verifying the Lender has the appropriate credentials to lend in that jurisdiction. For example, most countries require Lenders to be licensed. Once certified by a Credit Node, the Lender is able to work with any Credit Node to issue loans.

Question 2: Why are Credit Nodes necessary?

This question comes in many forms… one is: why not have Lenders and Borrowers simply use Bitcoin (BTC) or Ethereum (ETH) or LendLedgers’ token (LOAN) to transact directly? Why insert Credit Nodes?

We think Credit Nodes are absolutely necessary to manage the transfer of fiat currency on the blockchain and drive large-scale adoption.

Let’s look at this in further detail:

Transacting in Fiat for Ease of Adoption

Lenders, Data Providers, and Borrowers all conduct their business in fiat currency. A small-business Borrower generally can’t use cryptocurrency to purchase more inventory or pay employees or rent. What’s more, they don’t want a loan denominated in a highly volatile currency like BTC or ETH. A spike in the price of that currency might mean they are stuck paying back many times the amount borrowed.

Transacting in Fiat for Regulatory Concerns

Similarly, Lenders don’t want to assume the regulatory concerns or volatility risks associated with cryptocurrency. In many jurisdictions, lending institutions aren’t allowed to hold cryptocurrency. Beyond that, Lenders operate via a very predictable business model — they make money on the difference between their cost of funds and the rate of interest made lending out those funds. Cryptocurrencies’ volatility upsets the predictability of that model. It could leave a Lender with a loss on an otherwise profitable loan.

LedgerCredit as the Unit of Accounting

So if the participants in the lending ecosystem want to transact in fiat, but we need interactions tracked on the blockchain, how do we make this happen? Well, we can use a system of network credits and debits as a means of accounting on the blockchain. We call these LedgerCredit. And each LedgerCredit denotes an accounting obligation on the behalf of one party to pay the holder of the LedgerCredit.

Credit Nodes as the Solution

Which often leads to the follow up question: why can’t participants obtain LedgerCredit “directly” themselves? Why the need for Credit Nodes?

The answer is simple: participants have fiat and need a credit on the system. But who is going to accept that fiat and issue the credit? Who is going to hold the fiat in an account and release it to the recipient of the credit? If LendLedger, the company, does so, the system is centralized. We’d be acting as an intermediary for all transactions. So the system needs some group of participants to fulfill this role. These are what we call Credit Nodes. They take in fiat and give out credit.

You see something similar with other blockchain projects. Stellar uses anchors to issue on-chain representations of fiat currencies (e.g. USD). Factom uses federated servers to take in fiat currency and issue entry credits for the system.

Question 3: How do Credit Nodes generate credits for Lenders and other participants?

At a high level, Credit Nodes stake LOAN tokens with a smart contract that generates the LedgerCredit. In more detail… To generate credit on the system, the protocol requires the Credit Node to stake LOAN tokens of an equivalent value. This creates incentive for the issuer (the Credit Node) to redeem the credit from the Recipient for fiat currency.

To do this, the Credit Node sends LOAN tokens to the LedgerCredit smart contract, and specifies the party to which the credit should be issued.

The smart contract then holds the staked LOAN tokens until the credit (LedgerCredit) is returned to it. When returned, the LedgerCredit is burned and the staked LOAN tokens are released back to the Credit Node.

Question 4: Can you walk me through how a loan works? What does the Credit Node do?

To be clear, although we use loan disbursement as an example, all transactions on LendLedger work the same way. It’s always one party sending payment to another — whether this is a loan disbursement, a loan repayment or another payment.

Loan disbursement follows this process:

1. The Lender sends fiat currency to a Credit Node.
2. The Credit Node creates for the Lender a credit on the system (LedgerCredit). To do this, it stakes LOAN tokens.
3. The Lender sends the credit to the Borrower. This represents the loan.
4. The Borrower sends the credit to the Credit Node to receive fiat currency.
5. The Credit Node burns the LedgerCredit, releasing the LOAN tokens it staked.

You can also refer to our Tech Paper for a more detailed explanation.

Question 5: Who will be Credit Nodes and how will they be selected?

We are in discussions with a range of organizations about playing the role of Credit Node. These include lending institutions, financial inclusion organizations, Fintech companies, and others.

We are also still in the process of developing the application process and the selection criteria based on existing best practices developed by other projects, such as Factom, EOS and others.

It will be important that Credit Nodes have substantial operations and real world reputations at stake, in order to ensure trust and proper alignment of incentives.

We are also researching and developing structures for the ongoing governance of these entities. These will likely combine mutual auditing by the Credit Nodes, objective and/or quantitatively enforced policies, and community governance.

Question 6: Why would someone want to be a Credit Node?

Organizations will have a range of motivations. For some, like financial inclusion organizations, it is a way of participating in and supporting an effort to offer credit to a broader community. For others, it may be solely a business opportunity.

Question 7: How do Credit Nodes make money?

Credit Nodes are able, and expected, to charge a fee for their services. We anticipate Credit Nodes will charge a percentage fee based on the amount of fiat they handle (or amount of credit they help issue) for a participant. For example, if a Lender wanted to make a loan of US$500, the Credit Node might charge 1%, or US$5, to help generate that credit on the network.

Credit Nodes’ costs to run this business will include operational and capital expenses. Operational expenses may include costs to verify lending credentials, technology costs and others. Capital expenses are primarily working capital costs associated with staking LOANtokens.

Based on current research, we expect capital requirements to range from $30,000-$50,000 per $1 million in annual lending. If you assume the Credit Node charges in the neighborhood of 1% (or $10,000), you get a sense of the economics for the Credit Node.

It is expected that the Credit Nodes will compete with each other for this business on the basis of price, availability and reputation. Over time, this should work to ensure both quality performance and competitive rates.

Question 8: Don’t Credit Nodes create centralization?

Some in the community have expressed concern that the role of Credit Node reintroduces centralization. After all, won’t everyone on the network have to work through a Credit Node to obtain credit on the system?

While Credit Nodes do facilitate all transactions, no single Credit Node or group of them, will control the flow of transactions or information on the system.

What’s more, Credit Node financial incentives align them with the purpose of the network — they make money when they enable transactions. This is similar to validators in a Proof of Stake system, or miners in a Proof of Work scheme.

Indeed, Credit Nodes will:

• Be numerous.
• Be in open competition with each other.
• Be subject to new competitors (more Credit Nodes coming online).
• Be incented based on their business profile/reputation to act honestly.
• Be incented based on monetary gain to process as many transactions as they can.
• Be incented by their bond not to act fraudulently.

Finally, Credit Nodes will not own any of the information captured on the network or control how it is used for commercial benefit.

Have more questions about Credit Nodes? Check out part 2 of the Credit Node Q&A and take a look at our Technical Paper.

Have more questions about the workings of the LendLedger network? Ask us on Telegram, BitcoinTalk or Twitter. We’re always happy to answer your questions!