The street finds its own uses for things — William Gibson
Today, an estimated US$0.6 to 1 Trillion is transacted between merchants in Turkey every year, without any coordination from retail banks. Instead, “Vadeli Checks” an informal reputation-based community credit system using paper checks and trusted signatures is used, which allows any two parties to issue credit and transact with one another directly without the need for a trusted third party. The system has been refined and perfected for over forty years and has survived repeated currency devaluations and economic and political crises.
The following paper outlines Defterhane Protocol, a method of adapting the best features of the Vadeli Check system to the blockchain and community-based consensus mechanisms, enabling the system to be made available to anyone with a mobile phone or desktop. Rather than circulating paper checks, Defterhane Protocol uses smart contracts called Vadeli Contracts. A small fee is charged whenever a new transaction takes place. These fees are pooled and used to safeguard against default. The protocol itself is community-owned and uses a token-based governance system for making decisions.
- What is reputation-based credit?
- How do Vadeli Checks work?
- What do Vadelis teach us?
- Introducing Defterhane Protocol
1-What is reputation-based credit?
Defterhane Protocol is a blockchain solution that could replace the portion of commercial and retail banking services that operate on credit. Just as Bitcoin transactions can be faster and cheaper than traditional wire transfers and remittances, Vadeli Contracts executed on Defterhane Protocol will be cheaper, faster, fairer, and more community-focused than traditional banks.
Most cryptocurrencies hew close to Satoshi Nakamoto’s original conception of a trustless, peer-to-peer electronic cash system. In countries with a modern banking system, cash accounts for a small fraction of financial transactions. Almost all other financial activity, such as interbank payments, consumer and retail credit, mortgages, or loans rely on a degree of trust.
Bitcoin and its peers do an excellent job of replacing banks and trusted third parties for peer-to-peer cash transactions. Remittances, wire transfers, and certain DeFi applications requiring privacy all benefit from having an anonymous, identity-less payment system available. A glance at any major bank’s revenue stream, however, reveals how small a fraction of the banking system this is. At the Bank of America, less than a quarter of 2021Q1 revenue came from “non-interest” sources . A transaction requiring trust also involves an assessment of reputation. Credit reports, bond ratings, insurance premiums, and interest rates are all forms of accounting for reputation and risk during a transaction.
Instead of relying on the cryptocurrency equivalent of cash, Defterhane Protocol relies on transparency at the protocol and governance level, while keeping the identities and signatures of its users cryptographically secure.
Vadeli Contracts operate on the same principles that have guided trade for centuries. No collateral is ever at stake. Traditionally, a silk merchant, for example, would rely on his or her reputation within a small community to secure the delivery of a cargo of silk. They might shake hands over it. “I will agree to buy 10,000 TL of silk.”
Later, the signatures on a Vadeli Check gave a measure of portability to a loan: a borrower needed only to trust the most recent signature. The Vadeli Contract takes this concept and allows it to be extended anywhere that a mobile signal can reach.
In the United States and Europe, according to Seth Copen Goldstein’s (2020) BoLT: Building on Local Trust to Solve Lending Market Failure , the days of small community banks are coming to an end. National banks and mortgage giants have snapped up regional banking networks and replaced them. For a bank, the overhead for a large loan is no different from a smaller one; it’s become much less profitable for banks to employ regional bank managers who understand a community and are willing to take risks on small businesses. Trading and community-based transactions have been divorced from their communities.
Reputation-based lending can bring them back. Recentering business-to-business loans within a community would encourage local trade, create “circular” economies, tighten supply chains, and accurately price in externalities such as pollution and inequality .
2-How do Vadeli Checks work?
Turkey has an unusual relationship with checks. They’re almost exclusively written between merchants instead of used for retail banking, and they’re typically post-dated, often as much as twelve months in advance.  A check may also be transferred to a third party using a signature and a company stamp, becoming a Vadeli Check, provided the recipient trusts at least one of the signatures on the check. Each signee of a Vadeli Check is called a ciranta.
By the time a Vadeli Check circulates through the community and is cashed at a bank, it can accumulate dozens of signatures and stamps from multiple ciranta. This unique structure allows Small and Medium-sized Enterprises (SMEs) businesses to create their own liquidity.
From the bank’s perspective, a single transaction of 10,000TL (Ali to Demir in the example above) has taken place. From the market’s perspective, 10,000TL has been spent four times, creating four times the economic activity. In 2020, 16.8 million Vadeli Checks accounting for 975 billion TL (US$120B) were circulated, with an average check receiving five signatures, giving them an economic impact of $0.6 trillion. Approximately half a million Turkish merchants were involved in creating this impact in the same year.
The signatures on a Vadeli Check provide accountability and an immutable audit trail. A parallel can be drawn between Vadeli Checks and a blockchain: for every Bitcoin transaction, a digital signature from one owner to another is permanently and irrevocably recorded as a “block.” Each block is added in sequence to the previous transaction, creating a chain of digital signatures called the blockchain. In effect, the signatures on a Vadeli Check are a paper blockchain logging previous owners. If funds go missing or the check can’t be cashed when it comes due, the responsible party can be tracked down. These qualities allow both a blockchain and a Vadeli Check to create value without requiring a central authority. In the same way that a blockchain allows the creation of a distributed cryptocurrency, a Vadeli Check allows a merchant to create credit without permission from a central bank.
Defterhane Protocol uses the same structure as a Vadeli Check, only instead of using physical checks, transactions are recorded as Smart Contracts called Vadeli Contracts. These contracts are automatically executed on the Ethereum network, which is a fully Turing Complete virtual machine that has the largest network of nodes and the largest community of independent developers maintaining it, and has proven capable of handling large volumes of user activity.
3-What do Vadelis Teach Us?
Vadeli Checks are a living, breathing, forty-year-old business-to-business, peer-to-peer credit system. The system allows businesses to create predictable cycles of contracts based entirely on their reputations, and, aside from writing and cashing the check, the system operates entirely independently of traditional financial institutions. Annual turnover for Vadeli Checks in 2019 was estimated to be nearly USD$1 trillion, an economic impact larger than the country’s entire GDP (USD$761.4B in 2019) . This estimate is likely accurate, as it comes from the factorization sector, and presumes each check is exchanged an average of five times. In other words, Turkey has a fully functioning, completely independent, decentralized peer-to-peer credit creation system.
Peer to Peer Credit Creation actually works: The default rate is remarkably low. Over the past ten years, which have included a serious economic downturn, the default rate has fluctuated between 1.2 percent and 4 percent, which tracks closely with the American Delinquency Rate on Commercial and Industrial Loans, All Commercial Banks (DRBLACBS), according to the Board of Governors at the US Federal Reserve System .
Reputation is money: Vadeli is a reputation-based credit system that works between businesses without a third party. It doesn’t charge interest or demand collateral. Credit can be issued by anyone so long as their payee trusts them. Vadeli Contracts would be familiar to users and easily recognizable as a legitimate credit instrument in the Turkish commercial credit markets, given their similarity to other reputation-based instruments such as plain-paper IOUs and “live accounts.”
Communities benefit: The Vadeli system has an enormous impact on Turkey’s economic activity. Externalities can be priced into a loan. Money stays within a community. Issues that plague traditional commercial lending, such as systematic discrimination, bias towards larger loans, and asymmetric information risks can be avoided using localized loans. Transaction fees and interest are minimal. Central authorities can neither block loans nor collect information without permission.
Banks and the Government’s role is minimal: Merchants don’t have to keep any funds in the bank throughout the credit cycle until the loan matures and the check is cashed. The system is entirely legal, per Turkish law 5491 section c. This is not a black market, yet it dwarfs Central Bank-issued credit in Turkey. In April 2021, Government Domestic Debt Securities totaled US$151B (TCMB); less than the $200B worth of Vadeli checks issued (let alone their $1T estimated economic impact.)
4- Introducing the Defterhane Protocol
For most users, Defterhane Protocol will be an application on their mobile phone or desktop computer. Opening the app will take them to a user interface that resembles familiar financial applications such as retail payment apps like Venmo and Square or — to more sophisticated users — a cryptocurrency-wallet-based application like UniSwap. The software would allow users to check one another’s profile, issue lines of credit in the form of smart contracts, make payments, and monitor transactions. Behind the user interface, Defterhane Protocol is an Ethereum Network-based application.
a. Sharing Principles
A protocol is a set of rules that define how a system operates. Defterhane Protocol specifically defines a credit creation instrument that functions on the same principles that Vadeli Checks do. Instead of using a paper bank check, the system operates as an application on the Ethereum blockchain, providing a superior user experience and a far more flexible platform in the form of Vadeli Checks-based smart contracts, i.e. the Vadeli Contract.
Just as in the traditional Vadeli check system, users and service providers are the primary stakeholders of the protocol. Users will own the protocol in the long run. See section on tokenomics for more details.
Trust and identity are crucial. Defterhane Protocol complies with all Know Your Customer (KYC) banking requirements so that it can smoothly interoperate with existing banking systems and comply with local laws.
Once merchants have entered the protocol, however, they will be able to create confidential transactions using zero-knowledge systems to keep those transactions mathematically secure. During its first phase, the protocol uses the Credit Bureau of Turkey’s risk reports as a vetting system, until its own can be developed. This will consist of insurance, a scoring mechanism, and a Business to Consumer (B2C) interface.
In brief: loans will begin to be issued in the system between AAA-rated businesses with preexisting networks and liquidity cycles, as their loans function as the B2B equivalent of stable coins. The long-term goal for the system is much broader, and, eventually, the payment platform will be used for all commercial and retail transactions.
Defterhane Protocol is not a company, rather it is a technical protocol. The team working on it develops the peer-to-peer protocol and conducts research on peer-to-peer credit. Traditional Vadeli Check users are likely to migrate to the new platform in the long run. Sixteen percent of Turkey’s population owns or has owned cryptocurrency . The mobile application is designed to be user-friendly and the advantages of a software-based system, such as removing the risk of losing a Vadeli paper check will be appealing. We expect users to quickly adapt to the new Vadeli Contract system.
The Defterhane team consists of an organization (a foundation) engaged in financial and economic research and development in the field of peer-to-peer loans. They develop and maintain the Defterhane Protocol, although the protocol itself is open to the community’s developers. Anyone can propose improvements to the protocol and flag bugs.
c. Public Ledger
Defterhane Protocol’s name is a reference to the region’s long tradition of ledger-based accounting.  A “defterhane” was a ledger used to record taxing transactions during the Ottoman Empire.
Just as the Vadeli Check system uses a list of signatures and stamps as an audit trail for a single check, the Defterhane Protocol records all transactions that have taken place in a public ledger. The ledger allows the system to be completely transparent. A complete accounting allows loans to be divisible, and, by distributing the ledger across a peer-to-peer network, allows Defterhane to be decentralized across multiple nodes, making the system faster, fairer, more resilient and easier to scale, while eliminating hierarchies and the risk of asymmetric information, while motivating its users to participate.
A centralized hierarchy with top-down control — such as a central bank — resembles a pyramid. It’s fragile and liable to be bottlenecked. Edicts are issued from top to bottom, and a problem or delay can snarl the system indefinitely. The topology of a decentralized system is radically different. It resembles an interconnected network (more like a mosaic) with each node providing redundancy and failover capabilities for the other.
Vadeli Contracts don’t need the cooperation and coordination of the entire system to function; they only need a few users to connect to one another, yet every single node can be reached by every other node. Anyone connected can participate in a Vadeli Contract, yet it would be extremely difficult for a user to prevent someone else’s transaction from occurring.
Governance is another issue. Coordination of the system takes place through mutual agreement, or, in the case of Defterhane Protocol, through tokenized voting. When a decision is made, the codebase is updated and distributed throughout the entire system. Likewise, no one can issue an edict blocking a user or censoring the network without the consent of the majority of users.
Blockchain technologies take decentralization a step further by requiring a degree of work (or a significant stake) to make changes to the public ledger. This makes it prohibitively expensive for bad actors to hack or disrupt transactions.
A comparison might be drawn between a category of decentralized applications called decentralized finance (DeFi) and Vadeli Contracts. Both Vadeli Contracts and most DeFi applications are smart contracts that are built to run on the Ethereum Network (or Binance’s BNB network, which is an Ethereum clone). Where they differ significantly is that DeFi applications using debt require collateral. For example, flash loans, which are single-transaction smart contract loans, require 100% collateral to be staked.
The design specifications for Defterhane’s application are exacting: users have to be able to rapidly adjust from traditional Vadeli checks to the system, so it has to have features that are immediately recognizable by a wide variety of small business users. The application must be intuitive and easy to use. The cooperative part of the tool has to be present and comprehensible to users who are unfamiliar with blockchain technologies. Marketing and communications must ensure that analogies between Defterhane, the original Vadeli Check system, and commonly used contemporary payment applications are made. Implementation details are in a separate document.
Defterhane is designed to enable small businesses and individual merchants to create commercial credit and transfer it to others for debt settlement. The tool operates completely outside of traditional financial institutions.
This new instrument was inspired by Turkey’s Vadeli Check system. Defterhane aims to protect the existing Vadeli decentralized topology, while offering new features and solving some of the problems observed in the paper check-based Vadeli Check system .
Like the original Vadeli system, Defterhane is based on trust and reputation between businesses. The core mechanic is a promise made between businesses. Since there is no collateral backing the line of credit, the identity and reputation of the issuer is paramount. Defaults are covered by a pool of fees generated by each transaction, at a level determined by token holders.
- Users: consist of issuers, endorsers, and beneficiaries:
- Issuers create Vadeli Contracts,
- Endorsers guarantee transfers,
- Beneficiaries receive funds.
- Payment Carriers: Services that transfer fiat currencies between users at closure.
- Identity Verifiers: Services or agencies that validate KYC, verify users’ real identities, and their addresses within the Defterhane Protocol.
Wallet: Users interact with the Defterhane Protocol through mobile/web applications called wallets. These iterations consist of:
- Account management (creation, update)
- Line of credit creation and transfer.
Account: Users initiate their line of credit to the core layer through a wallet. The following data must be committed:
- Key management (signature, delegation),
- Service providers’ integration information.
Data registered and authenticated by the user’s signature is recorded in the core layer and encrypted. This data may only be read or updated by the user, and only within the parameters of their designated role in the Vadeli Contract (i.e. Issuer, Endorser, Beneficiary).
The identity field will carry a user’s real-world ID.
A sample template:
Key management tools allow each user to manage their account’s public keys.
A sample template:
Company managers often need to delegate their authority to subordinates. Defterhane offers delegation options for users who want to delegate. There are two different delegations in Defterhane Protocol:
i) Delegation of the account management,
ii) Delegation of credit line initiation and transaction management.
Service Provider Integration:
Payment Channel: How beneficiaries receive their funds.
A sample template looks like this:
Credit Line: Users create their promises as lines of credit and pass them onto other users. The following example shows how a line is created and recorded in the core layer.
The endorser in the above example can transfer the credit partially or as a whole down the line. While ownership data stays in the core layer, it transmits the identity of the issuer to the endorser via off-chain channels during the initiation of the new line. The issuer’s identity information is transmitted to all endorsers down the line.
Further Implementation Details:
- Our initial plan is to deploy on the Ethereum network,
- R&D to reduce network miner fees using Layer 2 solutions,
- R&D for using other potential blockchain platforms,
- Creating community tools for feedback and governance.
Our short term (one year) aim is to:
- Complete an MVP,
- Demonstrate a proof of concept in the field with real users,
- Implement our go-to-market strategy.
- Create a bigger team to develop a more mature product.
Our medium (two-to-three year) term aims:
- Attract wider interest and a global user base,
- Develop an internal scoring solution,
- Fine-tune the insurance pool, supply API for third parties,
- Do research for creating a dedicated sidechain for the product,
- Develop an SDK for outside developers,
- Create additional services.
The tokenomics of Defterhane Protocol are similar to projects such as MakerDAO; in short, an initial issue of 1,000,000 tokens will be distributed evenly between founders, investors, a development foundation, the community, and airdrops. Within five years of operation, the ratio is expected to adjust, with 90 percent belonging to a community of users and the remaining 10 percent held in a development fund. The tokens control a Decentralized Autonomous Organization (DAO), a cooperative decision-making mechanism that allows the community of users to make decisions such as setting the monetary policy, exchange rates, and uses for pooled funds and development tokens.
The distribution of one million Defterhane governance tokens is planned as:
- 20% reserved for initial investors,
- 20% reserved for founders,
- 20% reserved for development foundation,
- 20% reserved for airdrop and marketing,
- 20% reserved for actual users of the protocol.
As the system reaches equilibrium, we anticipate that the Defterhane Protocol will be 90% owned by the community of users and 10% owned by the development foundation.
 J. G. Haubrich and T. Young, “Trends in the noninterest income of banks,” Economic Commentary, Federal Reserve Bank of Cleveland at Cleveland, Ohio, USA, September 2019. [Online], Available: https://www.clevelandfed.org/en/newsroom-and-events/publications/economic-commentary/2019-economic-commentaries/ec-201914-trends-in-the-noninterest-income-of-banks.aspx
 P. Gohil, “Bank of America’s Revenue Breakdown (2016–2021),” Business Quant, March 31, 2021. [Online], Available: https://businessquant.com/bank-of-america-revenue-breakdown. [Accessed July 30th, 2021].
 S. C. Goldstein et. al, “BoLT: Building on local trust to solve lending market failure,” August 8, 2020. Available: https://www.cs.cmu.edu/~seth/bolt/bolt-draft.pdf. [Accessed July 20, 2021].
 S. Tumen, “Regulating check use in Turkey,” Central Bank of the Republic of Turkey at Ankara, Turkey, January 2021. [Online], Available: https://www.researchgate.net/publication/228517469_Regulating_Check_Use_in_Turkey.
 “Turkey,” World Bank. August 2021. [Online], Available: https://datacommons.org/place/country/TUR.
 Board of Governors of the Federal Reserve System (US), Delinquency Rate on Commercial and Industrial Loans, All Commercial Banks [DRBLACBS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DRBLACBS, August 4, 2021
 Central Bank of the Republic of Turkey. “Securities Statistics.” Türkiye Cumhuriyet Merkez Bankas, https://www.tcmb.gov.tr/wps/wcm/connect/EN/TCMB+EN/Main+Menu/Statistics/Monetary+and+Financial+Statistics/Securities+Statistics/ . Accessed 4 August 2021.
 K. Buchholz, “These are the countries where cryptocurrency use is most common,” World Economic Forum, Feb 18, 2021. [Online], Available: https://www.weforum.org/agenda/2021/02/how-common-is-cryptocurrency/. [Accessed July 28, 2021]
 D. Graeber, Debt: The First 5,000 Years. New York, New York, United States of America: Melville House, 2011.
*** Yearly turnover of the system in Turkey for the years 2018, 2019 and 2020 are calculated to be 940, 916 & 975 billion TL respectively. https://www.riskmerkezi.org/Content/Upload/istatistikiraporlar/ekler/2879/Bankalara_Ibraz_Edilen_ve_Karsiliksiz_Islemi_Yapilan_Cek_Bilgileri_-_Haziran_2021.pdf
This white paper was written and/or compiled by: Onur Kılıç (email@example.com), and Cemil Ş. Türün (firstname.lastname@example.org), English text by James McGirk (email@example.com) Many thanks to Yaman Can (firstname.lastname@example.org) and Berke Bora for their support.