Central credit and money system is in crisis and as world citizens we are expecting exposed players to dissolve and negligent conduct prosecuted. But instead we see a total bail-out of all players with dire consequences for the masses. Present level of technological innovations with fast information flows allow us to create new and alternative systems. In this paper, we propose a decentralized and transparent credit protocol that helps economic cycles of production and consumption run purely on information flows and without outside capital.
Commerce, industry and agriculture rely on bank credit based on the current central fiat currency regime. All companies, small and big, as well as people all over the world depend on a hierarchical fiat currency flow starting from central banks. Commercial banks in the USA “create” credit, extending on trust bestowed upon IOUs signed by the US Treasury, the amount being determined by the Federal Reserve Bank (FED). These IOUs are then used as a base to create money by the FED and their member banks. To understand how FED money is printed, it is necessary to realize that more than 90% of the money in use today is not cash, but credit added to banks’ ledgers. For the last several decades, this way of creating money has lost its touch with the real economy and heading to a demolition following the March 2020 crash. Just before the crash, total global debt was over 257 trillion dollars according to IIF which is more than three times the world GDP in 2019. Also note that the central banks of the world are part of the same global system via a common bank of settlements in Basel called Bank Of International Settlements (BIS).
Now look at the crimson area in the chart above, it is the difference between world production and global debt. By a simple judgement according to the size of the red area, one would have expected far better standards of living and increase in general wealth level for the world citizens in the last decade or so. However, it is fairly obvious that’s not the case.
On further inspection, one can see that the debt curve is not actually a curve but a hunchback composed of five or six steep slopes. However self explanatory, let us just for fun try to associate these straight sheets and their corresponding periods with six movies of the Star Wars universe: 1) “A New Hope”, 1980–90; 2) “Rogue One”, 1990–95, and “The Empire Strikes Back”, 1995–2001; 3) “The Phantom Menace”, 2001–2010; 4) “Attack of the Clones”, 2010–15; and 5) “Revenge of the Sith”, 2015–2020. One wonders what the next phase is going to be called? “Solo”? It’s obvious that the debt cycles drawn from real data in the chart above, displaying five or six lineer slopes are not god given, but resulted from un-natural, pre-planned events. Who do we owe this hunchback of a debt? “Men in Black” issuing the FED money? Are these same men also happen to be the creditors? How can we break free from these bleak scenarios?
2. What happened to the “invisible hand”?
We are witnessing an unprecedented bail-out operation which defies all logic of the dominant economic model of the last few centuries. FED has just printed trillions of dollars and bought out all positions on the table. The founding father of market economy, Adam Smith is rolling in his grave these days, and rolling many turns. Where is the “invisible hand” of the free markets? What happened to the fair market game? In the logic of this game, while someone wins at the table, another player is supposed to lose and go bankrupt. It cannot be a game where everybody wins and gets bailed-out by the Men in Black, using FED money. You just cannot do that! In that case it is not called Capitalism anymore. When there is a transfer of capital (or means of production) from private ownership of individuals into the ownership of society, then it is called something else.
It is obvious that there is going to be a reconfiguration of the world financial system as soon as the dust settles and reality kicks-in. Are we going to erase some debt and reshuffle the cards and re-start the same poker game from the beginning, say from 1980 as if nothing has happened? The present financial system is completely broken, and the world citizens may not go back to play the same unethical game again. Tables turned, lessons learned. We have to think what was wrong and define new rules for the new game. We must first accept the clear fact that with technology progressing toward more open source code and more transparency in this information age, any business built upon profiting from exploiting information asymmetries is bound to be demolished. That is exactly what’s happening now with the world financial markets: A total demolition due to technological progress.
We need now, new rules to end the existing stupidity and replace the central bank funny money with a decentralized ledger and a new peer-to-peer credit protocol. The new system must be based on real economy and definitely be fool-proof and ethically transparent.
3. DEF Protocol
In this article, we propose a solution modeled after a grassroots mechanism invented in Turkey circa 1980s, it is locally known as “vadeli cek” and helps any two parties transact directly with each other without the need for a trusted third party. By employing the Ethereum blockchain platform, we were able to develop a working prototype: See the DEF Protocol article for details.
Once the technical and operational details of the protocol are understood, one can take a fresh look at how credit systems should function in daily commerce and trade. Of the two figures below, the one on the left depicts the present situation: Centrally created credit by banks (F), finance goods and services production (P) and their consumption [C] in a hierarchical way. The gray circles labeled (F) are always between production and consumption cycles. Not a single flow is happening without going through a financial agent.
In comparison, the figure on the right shows a decentralized and peer-to-peer structure by using the DEF protocol. Note that there are no gray colored balls between production and consumption cycles, because they are not necessary.
When the gray (F) balls on the left start to pop, all the (P) and [C] circles connected to them also pop, losing connection to the whole network and eventually they will stop functioning: This is the unfortunate but expected result of the current system. We propose in this paper a new system with no (F) balls or bubbles, hence no possibility of exploding the (P)-[C] connection.
The application we propose, employs smart contracts and acts like a superconductor between production and consumption cycles. In the below figure, production (P) and consumption [C] are ideally like two nodes of a superconducting line, information current flowing both ways between them without friction.
The conducting line carries all distribution, logistics, ordering and purchasing information. A third node for outside credit is unnecessary in the ideal design as it introduces information asymmetry. A third party entering this cycle and is not itself part of a production or consumption node, will clog the channel and cause asymmetry.
The gray blob labeled (F) is representing the financial system destroying the natural cycles of production and consumption like a virus, by introducing information asymmetry. Financial agents behave like circuit breakers or information insulators since their benefit depends on arbitraging the two opposing nodes by introducing information asymmetry between them. By changing the ideal design slightly and placing (P) and [C] on the same feedback loop, we can completely eliminate the need for this outside intervention.
The oval shaped line represents the blockchain with smart contracts and acts as a superconductor between nodes. (M) represents the community of miners or other stake holders who maintain the application’s underlying framework. Note that there is no third party here labeled (F) since there is no need for outside credit. The information flow single handedly serves all necessary supply and demand needs and leaves no room for outside finance. The demand from the consumption side informs the system for further production, and the credit for the production of goods and services gets created within the system and stays inside the loop. Price information is also maintained with no hidden deltas between nodes. Every distribution and logistics information is also an integral part of the chain and they don’t need a fourth node as they may be considered part of the (P) node.
Ideally, (P) and (C) nodes should be able to form their independent cooperatives and stay strong together. When there is cooperation inside a node and also there is balance between two nodes then there is no need for any outside intervention. At that point, the system will not need a separate (M) node either; every user will have an app running in their smart phone and all users will be miners. The network of users itself plays the role of the superconductor and may itself also become the cooperative platform.
5. Hidden deltas and other ethical considerations
Generally, technical system architects tend to think that the source of all evil in the money printing business is the amount of money created and the issuers’ unaccountability for their actions. This analysis is inadequate as the introduction part of this paper shows us. Lack of integrity reveals itself to us, in ways more fiendish than accountability flaws or impudence for printing trillions of dollars. In the present financial system, there exist hidden deltas, undocumented assumptions, zero transparency and lots of forceful imposition from top to bottom. We can do better: we can build an open source, world wide protocol for peer-to-peer credit creation where all users are held accountable for their actions throughout the system by transparent evaluation mechanisms.
Integrity should be the essential part of the new credit system. Everything must be transparent, open source and visible from the outside to any honest viewer. We need banking and credit but not necessarily banks. We need to run our agriculture, industry and commerce efficiently without any outside involvement. We need production and consumption cycles but we don’t need capital. Information symmetry is enough to keep our economic wheels turning with an internal credit mechanism. In this paper, a transparent and decentralized protocol with smart contracts for creating and terminating credit lines in any commercial environment is proposed. The most essential part of the protocol is ethics and as such it has been made an integral part of the code by making sure everything is open source and transparent.