Lending yourself money, from assets you own. Interest-free.

I previously talked about liquidity and money on blockchains. I find this a very interesting subject. I believe, some of the greatest benefits that blockchain technology will bring to the world is disintermediation in liquidity, custodianship and brokerage. That is, without any middle men, having the ability to easily swap between different types of digital assets (liquidity), keep assets safe (custodianship), and automatically execute on agreements (brokerage). I will put this into some perspective…

The world used to be liquid

Thousands of years ago, when societies were smaller and people trusted each other more, a wheat farmer could easily become liquid, without having to wait for a buyer of her crop. The way farmers achieved this, was by depositing her crop with the village’s church. Since something valuable was locked into custody of the church, the church would mint a token (a clay tablet) equal to the value of the crop. The farmer was now liquid, as she could go and exchange, buy or re-invest with that token.

At any time the farmer would come back and take her crop out of the church’s custodianship. What would then happen is that the church destroyed the token that was originally minted for this asset. Note: It’s important that the church destroys that token when returned to not create a fictitious surplus from the exchange.

In a sense, the church was a broker that took assets into custody in order to provide liquidity.

The world has become illiquid

Today, farmers have become illiquid, because there’s no easy way to instantly liquidate crop. A farmer has to wait up to 90 days after delivering its crop, until the invoice is paid. There’s a liquidity gap; a period of time without cash. This inhibits economical growth, because the farmer can’t pay its workers, reinvest, or otherwise leverage its own assets (technically the farmer owns the delivered crop, until payment).

The future will become liquid again

The key to liquidity and unlocking economical growth without middle men is to make it frictionless to (1) swap assets (2) having the ability to lock-up assets in custody and (3) automate brokerage of such assets.

If you didn’t already guess, this is where blockchains and smart contracts come into the picture. Imagine if the right, or ownership, of wheat crop was captured in a legally binding smart contract. Remember how the church took responsibility of custody and brokerage of that crop in exchange for a more liquid token? With blockchain tokens, the farmer could easily lock-up the right to her crop in a smart contract, in exchange for minting digital cash equal to the value of the crop. That smart contract would then release the crop and burn the digital cash when returned. Note: It’s important that the smart contract burns that cash when returned to not create a fictitious surplus from the exchange.

If the farmer is unable to re-pay the cash, the smart contract will sell the right to the crop for a fair market price.

What has happened here is that the farmer has lent herself money, from assets she owns, completely without middle men and interest payments.

The reason why this is fundamentally different to a house mortgage, is because with a mortgage you are just moving existing money, or renting existing money; essentially, creating money out of no fundamental value (other than pure risk-taking by the bank).

This is possible today

In a basic way, it’s possible to achieve the above liquidity today. I can lend myself money, from digital assets I own (i.e. Ether), by creating a CDP (collateralised debt position) in exchange for digital cash called Dai. These Dai tokens have a stable value (against USD) and can be traded and leveraged for other tokens or services. At any point, I can wipe the CDP (the debt) by returning the Dai in exchange for my Ether assets. I wrote about this in a bit more detail in the past.

The Dai stable token is provided by the MakerDAO protocol. A similar protocol, but with even more ambitious goals, is being built by Sweetbridge.

Dai tokens can be traded for other tokens on decentralised exchanges such as Bancor, OasisDex, Radar Relay, and probably on Kyber Network when it’s launched.