In the previous article, we looked at what influences the fiat economy interest.

The focus of this article is the crypto economy. We have three parts here:

1. We look at the same factors, which are influencing interest in the fiat monetary system:

• The individual’s preferences to consume, invest or borrow
• The individuals preference short term versus long term borrowing or investment
• Rate of base-money production/destruction in the economy
• Rate of credit-money production/destruction in the economy
• The proximity of individuals to the “money creation” in society

2. We calculate how much should be the base interest (interest without the credit risk) in the crypto economy.

3. In the end, we compare the fiat monetary system with the crypto monetary system. We see as well, which system benefits which segments of the population.

1. Consumption preferences

Consummation preferences are presumably the same as in the fiat economy.

However, crypto users are rather younger generations / Millenials, which are characterized by relatively low saving rates and higher consummation preferences. i.e. the demand for borrowing is bigger than the demand for lending. This factor translates into higher interest.

2. Time preferences

Time preferences for crypto user sare very similar to the consummation preferences. This factor translates into higher interest as well.

3. Rate of base money creation /destruction

Rate of base-money production/destruction – Bitcoin, Ether, Dash, Litecoin, etc. have built-in growth mechanisms/inflation mechanisms, where miners are getting paid with the freshly minted crypto-coins for providing the infrastructure for the decentral networks.

These platforms are open source platforms, but the costs for running network infrastructure (hardware, bandwidth, and power) are real and they need to be financed. The built-in inflation mechanisms are the solution for financing the real network infrastructure costs.

This crypto-monetary expansion is at the moment following:

For example – Bitcoin monetary inflation is 4.29% per year and Litecoin monetary inflation is 8.41% per year.

4. Rate of credit money creation /destruction

Rate of credit money production/destruction – today’s fiat credit money – the commercial banking money, which is 95% of the total money – this is missing at the moment in the crypto economy. Crypto economy has only base-money. Crypto sector does not have the credit money yet.

The credit money has been around for the last 5’000 years, the first instances of the credit money are known from Mesopotamia and it was created in the peer to peer transactions. Credit money was created in peer to peer way for the first 4’700 years until the commercial banks started to emerge ca 350 years ago.

Then the “private credit money” of the commercial banks emerged and after the introduction of the central banking, we arrived into our current “central credit money” incarnation.

Let’s put this in the perspective – our current fiat monetary system is 100 years old; the credit-money exists in different incarnations for the last 5’000 years. As credit-money has been around so long, we support the thesis, that it will emerge as well in the crypto sector.

5. Store of the value function

Store of value is very strong in Bitcoin. It’s called as well the “digital gold”. Store of the value function is present in other crypto-currencies as well, but less strong than in the Bitcoin.

Crypto-currencies are not manipulatable by the central instances as the base-money or credit-money in the fiat economy. This missing manipulation is the basis for the store of value in the crypto monetary system.

As there is no-manipulation compared with the fiat monetary system, then this results in higher demand for the crypto-currencies, which translates into higher interest.

6. Proximity to the money creation

Proximity to money creation – base-money is created by decentral means and it finances the miner’s operations. Decentral credit-money is still missing in the crypto sector, but it should be the only question of time until it will emerge.

If we decentral credit-money will emerge, then the proximity to money creation will equalize between the wealthy and the un-wealthy. It’s not only corporates and wealthy, who will be privileged, but everyone will be privileged to receive crypto credit or credit-money.

7. Summary of Factors

Here is the summary of the factors for the crypto-interest:

The following will answer the key question of this article – how much should be the base interest for the crypto sector – we look this at the example of Bitcoin and Ethereum.

These would be the estimated base rates for the crypto base interest rates. I.e.if lending crypto, then the interest rate should start from this area.

9. Comparison fiat interest rate versus crypto interest rate

This table summarizes the above discussion:

In every monetary system, there is interest – the price to be paid for using someone else money. In this article, we focus on the “base interest” – i.e. how much should be the interest, if there is no credit risk.

We focus here on two topics:

• Which factors influence the base interest in the fiat sector?
• How much should be the base interest in the fiat sector?

The drivers for the interest are:

• Consumption preferences
• Time preferences
• Rate of base-money production/destruction in the economy
• Rate of credit-money production/destruction in the economy
• The proximity of individuals to the “money creation” in society
• Store of the value function

First, we analyze these factors and then we conclude how much should be the base interest in the fiat economy.

1. Consumption preferences

The output of the economy is expressed as GDP – Gross Domestic Product. There are multiple ways to define what the GDP is, but for this article, we use the following definition – GDP the sum of all income paid to persons (not to the companies, but the natural persons). So, the persons are receiving an income and then they decide how much to consume or to invest/save.

The interest is the price for the money, it’s the price, which has to be paid to someone else for delaying his consumption.

High interest would imply, that rather a small number of persons would like to delay their consumption – this results in the shortage of money in the economy – therefore the price for money – the interest – will be higher than equilibrium.

Low interest would imply, that rather a big number of persons are confident to delay their consumption – this results in the over-supply of money in the economy – therefore the price for money – the interest – will be lower than equilibrium.

By adding all these different wants of different individuals together we will get the fixed income markets, which intermediate between the “endpoints” – between the natural persons.

7. How much should be the base interest based on inflation?

Inflation is defined as a loss of purchasing power of money. Mainstream macroeconomy presents the orthodox view that healthy inflation is always required and healthy for the economy. U.S. Fed for example targets 2% inflation per year.

This struggles us because the productivity increases continuously due to the innovation, which should lead to the decline of the prices, i.e. to the deflation (opposite of the inflation). This healthy deflation is beneficial to the savers because they will be able to consume more real assets (opposite to today’s situation, where money buys less and less).

However, as central banks are using monetary instruments to create inflation, then we have inflation in the economy.

Back to the interest – the base interest in the economy should be at least as much as the inflation, i.e. it should compensate for the loss of the purchasing power of the money.

This leads us to the question – how much is the inflation in the today economy? We have to distinguish between the:

• Official inflation and
• Real inflation

Official inflation calculation is “kind of optimized” – let’s think here on the transfer costs (health insurance costs are not included) and substitution effects (one should eat chicken if beef prices grow too much). The fact is that the official inflation calculation was changed in the 1990s. It is now circa 2.5% in the U.S.

Real inflation, based on the before 1990’s method, should be around 6% per year in the U.S. (please have a look at the www.shadowstats.com for the backgrounds).

This implies that the base interest should be ca 6% in today’s economy.

8. How much should be interest based on the rate of total money growth?

There is a total output of the economy (GDP) and there is a total amount of the money in the economy (so-called M3).

There are two scenarios for the base interest:

• Inflationary scenario – Amount of money is growing faster than the output of the economy. Money can buy less and less – the purchasing power of money will decline.
• Deflationary scenario – Amount of money is growing at a slower speed than the output of the economy. This would be a natural scenario due to the continuous productivity increase through continuous innovation.

The first scenario helps the party’s with huge liabilities – for example, our governments. Having higher inflation allows to reduce nominal liabilities, it allows to “inflate” the debt away.

The second scenario helps anyone, who are borrowing for investing in the real assets – either for buying a house or for the retirement or for the kid’s education. This scenario is the best for the middle class.

The rate of credit money growth is circa 6% in the U.S, based on the discontinued gowernment M3 statistics, however recalculated by ShadowStats:

This implies the base interest should be as well ca 6%.  otherwise the money would lose his value just by staying on the bank account.

9. Why are the central bank interest rates so low?

Central banking is driven by the philosophy that there has to be inflation in the economy. Negative inflation (or deflation), which would be actually beneficial for the savers, is considered something very bad by the central banks…

Central bankers will explain their view in the following way – if the value of money will increase over time, then the consumers start to delay consummation decisions; enterprises will not invest, and all economy will become to the standstill.

Well, central bankers forget that the, for example, the U.S. economy before the creation of Fed was a deflationary economy – it was economic boom time and it was the time where the savers become wealthier.

But why then this misconception in today’s central banking? Well, the trigger is the amount of credit money in the economy. Today’s economy is significantly over-leveraged by debt. The pre-Fed economy had much lower debt ratios. There was a clear separation of the base money (gold) and credit money in the pre-Fed area. Credit money was temporary and was always reversed back into the base money (gold). This system didn’t allow to create debt bubbles.

It’s not the fear of deflation, it’s the fear of the debt bubble, which keeps the central bankers inflating the system. Our current system doesn’t have a clear separation between the base-money and credit-money. Credit-money was supposed to be temporary and always reversed back to the base-money. But this is missing – we have not temporary but a permanent credit-money, which leads through inflationary policies to ever-growing bubble.

By lowering the central bank short term interests, by Quantitative Easing, by lowering the balance sheet requirements to the commercial banks – all these instruments are there to create additional amount of credit money and via this additional inflation and to prolong the status quo.

10. Reflection

Let’s reflect the key points from here:

• Base interest in the economy based on the credit-money growth should be around 6% (if lenders receive less than they lose value)
• Base interest in the economy based on real inflation today should be around 6% (if lenders receive less than they lose value)
• Access to credit is challenged to the majority of the population. The banking system should bring financing to the end-points of the economy, but the “money does not arrive in the real economy”. The ones, who have higher proximity to the money-creation, have access to the credit. The others (the 99%) are in a challenging position.
• The wealthy, who have high proximity to the money creation, have to pay lower interest rates than the real base interest in the economy. The un-wealthy, with their low proximity to the money creation, have to pay higher interest rates than the base interest.
• The results in continuous wealth transfer from the un-wealthy to the wealthy, from the ones who are not close the financial institutions to the ones who have high proximity to the financial institutions – year by year, generation by generation.

The current fiat money intermediation system is “kind of de-functional” in the current state.

It is not designed to keep and expand the middle-class. It’s current design and implementation leads to a continuous wealth transfer from the non-wealthy to the wealthy. It leads to society with 1% and the rest.

All loans are tokenized on our platform into one standardized ERC 20 contract. This tokenization makes to loans transferable. The loans are protected with the collateral and loss provisions fund. This means the lender can use the tokenized loans as a mean of payment.

It works in the following way:

1. When the loan is issued on the marketplace and Ether is transferred to the borrower, then the lender will receive the same amount of freshly minted credit coins (we call them Smart Money tokens)
2. The lender can keep all these credit coins till the end of the loan, by when they will be replaced with the borrower’s interest and principal payments.
3. Or the lender can pay with the credit coins the next parties, which can pay the next parties and so on. The final holders of the coins will receive interest and principal payments.

This means that the lenders will be liquid even after they lend out their assets – they can use the credit-coins, which get assigned to them, to pay the third parties.

Why is having liquidity important? Let’s imagine, that lender has lent out all his funds but needs to make some un-expected payments to third parties. The only way for him would be to take a loan. That’s how it would work on all fiat P2P or crypto P2P lending platforms – except SmartCredit.io.

Having liquidity option means the lender doesn’t need to take the bridge loans. It means, he can use his own loans, which are tokenized and value protected, to pay the third parties.

How would lender know who would like to receive his credit coins? There are two ways – the lender can do advertisement to SmartCredit.io and add new members into the network or he can send his credit-coins to the private fixed-income funds and receive the Ethereum in return.

There are several key differences from our competitors:

1. Tokenization of Credit and creating Liquidity for the lender – we are the only ones doing this. We are tokenizing the loans into the standardized ERC 20 tokens. The holders of these tokens will receive the interest and principal payments of the underlying loans. If the lender does not transfer these tokens to third parties, then the lender will receive all principal and interest payments. If he has transferred some of the tokens, then interest and principal are distributed pro-rata from between token holders.
   Tokenization of credit results in the liquidity for the lender – he lent out his assets, but he is still liquid after he receives freshly minted credit-coins, which lender can use as mean of payment to the third parties.
2. Private keys belong to the clients – no one else can access the client’s assets. Although it sounds too basic, most of the platforms have not implemented it so – either the clients have to transfer their assets into dedicated platform controlled wallets or there are multi-signature on the addresses. In both cases, it’s not the client, which controls the assets.
3. Fully decentral marketplace – if platform controls client assets, then this results in regulatory requirements for every borrower’s jurisdiction (usually it’s the financial intermediary license). As most of our competitors do not have these licenses and as the number of users is continuously growing, then it’s the only question of time, till the regulators will awaken and will “drink some tea” with the respective providers.
4. Automated credit risk rating via social media, ethereum blockchain history analysis and psychometric analysis. The client can choose not to process with an automated credit risk rating, in this case, he would be assigned into the “standard” credit risk bucket
5. Loss Provision Fund. Our competitors need always to prepare for the worst. I.e. they have to significantly overcollateralize to loans on their platforms (so that they can sell the collateral in case of adverse market events). Having Loss Provisions Fund and allocating a small piece of every loan into the Loss Provisions Fund allows better to deal with the adverse market events and to reduce the collateral requirements.
   If the borrower is defaulting, then his collateral will be liquidated. If it’s not enough of collateral, then the Loss Provisions Fund will take over the remaining difference.
6. Self Re-Inforcing Ecosystem, which provides usability to the borrowers; immediate liquidity to the lenders and passive income to the investors on their crypto holding. And on every step, it’s only the client who controls the private keys. Only the client and no-one else.

Hi guys, this is Tarmo speaking.

Hi guys, I’m Martin, I’m Co-Founder of SmartCredit.io. We are here in Zurich in one of the financial centers in the world. And we are in the heart of the financial center in the old town of Zurich.

Martin, you are Co-Founder of SmartCredit.io. What is the idea of SmartCredit.io?

The key idea of SmartCredit.io is to create credit-money for the crypto sphere. If you are thinking of Bitcoin, everyone speaks about the Bitcoin, but Bitcoin is just the base money-in the same way the base money, as central banks are creating the base money.

But let’s think on the economy. In the real economy, people are using credit-money. Base money is 3% – 7% of the money and 90% to 97% is the credit-money.

If you are thinking of Bitcoin and Bitcoin economy then we have only base money. Real economy needs credit money. It has not been so in the last 5 years or in the last 50 years. It has been so for the last 5’000 years.

There is a simple reason for this – production, farming – it needs time. We have to pay for energy, we have to pay for the labor, we have to pay for the time. Everything needs to be financed. And this financing, in the last 5’000 years, has been done with the credit and credit-money.

Back to the Bitcoin – Bitcoin is missing the credit-money approach. What we want to introduce is the credit-money approach into the crypto sphere and to achieve this enabler of higher penetration of crypto technology and decentralization of the economy.

How does the credit-money creation work today?

Let’s speak about the base money creation – created by central banks like Swiss National Bank, European Central Bank or Federal Reserve – the base money.

But the credit money is created by private companies – these are the commercial banks. And credit money has to be legally accepted as a mean of payment. Private companies are creating fiat money and public people have to accept it.

How is it created – it’s created in the lending transactions. If I am taking a loan from the bank, then the bank is actually creating new credit-money and he is lending me this credit-money. Bank does not own the money, what they are lending to me; they are creating it and this is a legal mean of payment in the respective national economy.

You mentioned lending, but lending is a risky business?

Everyone is saying that lending is a highly risky business. Now, let’s look from this way – commercial banks have most of their business created through lending.

If we are taking a traditional bigger commercial bank, then 40% or so of the profits are through the lending business. The lending business is a money creation business.

Commercial banks are doing the risk analysis of the clients, they are calculating how much a client can borrow and all other parameters. Commercial banks are doing this for many years, they are doing this for hundreds of years. They have developed the systems and like said – around 40% of commercial banks profits are created through the lending business.

Do you want SmartCredit.io to become a decentral commercial bank?

We have commercial banks, they are creating credit-money, and in SmartCredit.io our aim is as well to create credit-money for the crypto sphere. But we do not want to be a bank.

We want to be a marketplace – we want to be a marketplace, where we are connecting borrowers and lenders globally. So that people can provide to each other the credit and from this credit, we create the credit money to pay the next persons.

Actually, we are doing everything that commercial banks are doing. But we are doing this without being a bank – we are doing this by being a marketplace.

Very interesting! Let’s take customers viewpoint – what can customers get from SmartCredit.io?

Let’s take a borrowers viewpoint and let’s take a lenders viewpoint. For the borrowers, it means a very advanced credit process. We are doing automated credit risk rating by the registration, so we know credit risk and borrower gets fast process. Compared to our competitors we have many advantages and much less collateral and so on. So, that’s for the borrower.

If we are looking on the lender – the key advantage of our system is – when I’m lending Ether to another peer-to-peer person in the world – I’m lending out my Ether and I’m receiving Smart Money tokens, which is the crypto credit-money and I can use this crypto credit-money to pay the next persons.

So, I’m lending out my money, my Ether; and I receive crypto credit-money – Smart Money tokens, which exists as long, as the loan exists, and I can pay next persons with this.

Sorry, do you mean that I can earn profit and in parallel I am liquid?

Exactly. That’s what the commercial banks are doing at the moment – they are liquid and they earn a profit – because they are creating credit-money.

So, I can earn profit from my Ethereum funds and still have liquidity. It sounds like a miracle?

Again, commercial banks are doing this. When I am a lender, I’m lending out my money, I’m receiving crypto credit-money. And this crypto credit-money, the Smart Money tokens, are the mean of payment to pay the next parties.

Commercial banks are creating credit-money, I’m as a borrower- I’m receiving it. In SmartCredit.io as well we are creating the Smart Money tokens and through this the lender has liquidity. He has immediate liquidity.

And not only that he has liquidity – who is keeping Smart Money token, will receive as well interest. If I am passing my tokens to the next person, then he will earn the interest; if I am passing to the fifth person, then he will earn the interest. So, it’s pro-rate interest is earned from the holders of the tokens.

So, it’s not only that I have liquidity – we distribute as well the profits from credit creation to the peer-to-peer network.

It sounds wonderful! Can you tell a little bit more about these Smart Money tokens?

SmartMoney tokens represent the claims. There is a borrower and there is a lender. The lender is receiving Smart Money tokens. If the lender is lending 5 Ethers, he will receive 5 Smart Money tokens. And the owner of Smart Money tokens is as well the interest.

Smart Money tokens are backed up with the respective claim, with the respective lending contract. Smart Money tokens are protected, that means their value is always one Ether. We have a protection mechanism, it’s a unique protection mechanism, which is protecting the value of Smart Money tokens.

If commercial banks are creating the credit-money, they are protecting the value of credit-money through their balance sheets and reserves. The same way SmartCredit.io is protecting the credit-money through own protection mechanism.

So, this means – Smart Money token represents the claim, it can be used as a mean of payment, it collects interest to the holder and its face value protected.

Sounds really like a break-through innovation?

What we are doing – we are just mirroring what commercial banks are doing today. Commercial banks are doing this in a centrally. It has been so because of scale effects and lower transaction costs.

Thanks to the blockchain it will become possible to do all this what commercial banks are doing in the lending business, where they generate 40% of their profits to the view instead of the many. Thanks to blockchain technologies it will be possible to decentralize all these logics – for the benefit of many instead of the benefit for the few.

What are your future plans?

The first step is to create a decentral marketplace for the credit, then we create credit-money. The second step is to create a crypto credit- card. But this is not the credit-card or debit-card, which are connected with the huge existing credit card businesses.

We want to create virtual crypto credit card, without having any connectivity to existing credit card businesses, but having only SmartCredit.io account, which you can use the in online shops and by the online merchants.

So, you can buy from an online merchant on credit and it’s all backed up with the Smart Money tokens in the same way as in lending transactions.

So, the first step is – we are creating a peer to peer decentral lending and the credit-money; the second step is – we are creating virtual credit cards, what can be used in the online processing.

Here is the transcript:

Hello guys, I’m Martin, Co-Founder of SmartCredit.io. We are here in Zurich, in the heart of one of the biggest financial centers. We will speak today about credit and credit-money.

Martin, how do worlds credit system work currently?

It’s actually a pretty simple system, but it’s made very-very highly complex, so that’s it difficult to understand. But let’s explain it in this way:

One one side there are central banks, they create the base-money and they try fo control the speed of monetary expansion. One other side we have commercial banks and commercial banks are creating the credit-money.

What is the exact role of central banks in this system?

Central banks are creating base money – these are the coins and electronic base money. In parallel the central banks, what they are trying to do is to control the speed of credit-money creation. Credi-money is created by the commercial banks, it’s ca 90% – 97% of the total money. The base-money is 3% – 7% of the total money.

And what central banks are trying to do is to manage this system.

And how successful are central banks in controlling the growth speed of credit-money?

That’s a point of a view, depending whom do you ask. If you ask central bank guys, there are many of them, then they will tell you obviously that it’s very successful.

My comment on this is – economies are living systems. And to control living systems from a part of the living system is quite difficult. We see that the credit-money growth has been actually the cause for the most of economical crisis – the Russia economical crisis or Asia economical crisis. If credit-money is growing too fast, then there will be as well the phase where credit-money will be declining. The decline will result in recession.

Obviously, central banks are saying that they are doing a perfect job, but there are different views about this topic.

You speak about the credit-money and you speak about the credit. What is the difference between these two?

Credit is so that anyone can give credit to anyone – it’s our basic right, it’s basic law – I can give credit to anyone. Credit is becoming credit-money if my counterparty is giving me a claim (I’m a lender in this scenario) and I can use this claim as a means to pay the next persons. That was the way how the earlier monetary systems worked.

Practically the credit-money was created decentrally, it was created peer to peer. And there was the base-money, which was then created by the kings, the sovereigns. On top of the base-money, was the credit-money, which was created by people for people.

And concerning credit-money – the amount of credit-money, why is the amount of credit-money important?

We have a base-money, that’s what central banks are creating. The economy is growing, it’s like a living organism – if a living organism is bigger, then organism needs more blood in his body. If a living organism is smaller, then he needs less blood.

And the credit is like the blood in a humans body. If there is fast economic growth, then we need automatically more credit. If there is low economic growth, then we need less credit. This problem cannot be solved with the base-money only, this problem has to be solved with the credit-money. That’s why the credit-money is very important for economic development.

If there is no credit-money, if there is only the base-money, then it will probably end up in the deflationary economy, because the price of the money will be too high for the fast growth phases. That’s the reason for the credit-money.

In today’s world, we have commercial banks and central banks. When did the commercial banks emerge?

People think that commercial banks have been there forever. Actually, it’s not so. The commercial banks started to emerge like 350 years ago. The first central bank was created in Sweden, it was around the 1660’s; the second one was created in London around the same time.

And the first commercial bank was Netherlands Wechsel and Handelsbanken, the role of this bank was to trade the wechsels, because peer to peer money creation was based on the wechsel, in English: bill of the exchange system. That’s the first commercial bank was created.

However, the economy worked as well before, and it worked pretty nicely before the commercial banks were created.