What is Mutual Credit?
ReSource is a Mutual Credit protocol that allows participants to access credit at extremely competitive terms, while freeing them from their dependence on external capital providers such as banks, creditors, or even investors.
Arguably, to many this may sound too good to be true. After all, who in their right mind would lend money to anyone without charging compounding interest or while settling for minor fees that are easily outcompeted by better investment opportunities? To answer this question we first need to understand what Mutual Credit is, what its shortcomings are, and how ReSource uses blockchain technology to overcome them.
What is Mutual Credit
Before we begin, let us clear some confusing terminology. Mutual Credit shouldn’t be confused with Mutual Banking, Cooperative Banking or Credit Unions. While Mutual Credit shares similar ideological roots with the now widely proliferated concept of Cooperative Banking, the two terms refer to two different institutions. While a Credit Union is just a normal bank that happens to be owned by its customers, sharing profits with them and offering them fairer terms on their loans, Mutual Credit is a much more radical concept, attempting to fundamentally change what credit actually is.
Operators of mutual credit networks are not creditors who use their own capital to provide loans to borrowers, nor are they intermediaries who lend “other people’s money” to third parties. Rather, mutual credit networks facilitate trust among their members, which allows them to engage in reciprocal trade with each other. “Reciprocal trade”, also called “multilateral exchange”, essentially means complex barter with many participants.
Simple barter, also called “bilateral exchange”, normally entails two parties directly exchanging goods and services: Alice has a banana and gives it to Bob in return for an apple. If Alice has a banana, but doesn’t want Bob’s Apple, the two can involve Carol and form a multilateral exchange network: Alice gives her banna to Carol in exchange for an orange, who then gives her newly acquired banna to Bob in exchange for his apple. Mutual Credit builds on this principle, but extends it significantly with the help of an elegant bookkeeping method that allows anyone within a mutual credit network to buy from and sell to anyone else without using traditional forms of money.
“Credit” within this context, is not the allocation of existing capital to a borrower, but the privilege granted to a network member to receive goods and services from their peers against a promise to provide equally valued goods and services to other members of the same network in the future.
These “promises” to provide goods and services in the future behave, to some extent, like tradable and fungible IOUs that can circulate among network members in the same way money circulates in an economy. This allows mutual credit networks to create their own, circular monetary systems, which are backed by the ability of their members to fulfill their promises.
Consequently, being able to create their own money, mutual credit systems are freed from the need to “rent” capital from a creditor in order to lend it out to network participants. This trick is what allows mutual credit networks to extend credit at fee rates that are significantly more affordable than the compounding interest payments charged by banks and other lending institutions.
“Creating your own money” may sound dangerous; or even shady, but it’s far from it. mutual credit networks don’t create money at will, but rather enable their members to mint money in exchange for an obligation to accept the minted amount as a means of payment in the future.
This way “new money” enters circulation in conjunction with new spending opportunities for said money, and as we’ll see below, with new demand exercised on it. In other words, for each unit of mutual credit money exists at least one party within the network that is obligated to accept it as a means of payment. As long as these obligations are adequately enforced and insured, mutual credit money possesses a degree of “intrinsic value” which other alternative currencies (such as Bitcoin or other cryptographic assets) lack.
The example below depicts a simple mutual credit system with only three members: Alice, Bob, and Carol. The three of them don’t have any money, but they do have productive capacities. All three of them are able to deliver goods or provide services — if not now, then at some point in the foreseeable future.
Money is introduced into the system once a participant, Alice, decides to purchase an item from another participant, Bob. When she does so, a deficit is created on her account and a deposit appears on Bob’s account. This way money is effectively “spent into existence”.
In the same way, Carol overdrafts her account in order to purchase an item or service from Alice. This returns Alice’s balance to zero.
If Bob now decides to purchase an item or service from Carol, his deposits will be remitted to her, covering Carol’s deficit while returning both of their balances to zero. At this stage, the network will return to its equilibrium zero-deposit state in which no debt, and hence no money, exists within the system.
You may have already spotted an important attribute of mutual credit systems: The amount of money within it equals the amount of debt, or obligations among its members. This is where mutual credit money derives its intrinsic value from: each money unit in existence is required by someone within the system to pay their debts. This means that the existing money supply always matches the demand exercise on it by outstanding loans.
As a three player game, this system is obviously very limited in scope and utility. For this to make sense, we need to presuppose that Alice, Bob and Carol are able to match each other’s demand with the supply they are able to generate. However, not dissimilar from Social Networks, the ability of the network to match demand with supply grows exponentially with its size. While a trading network consisting of hundreds of members can facilitate meaningful trade, thousands of participants already constitute a functioning micro-economy.
Where's the Catch?
Ok, so if it is that easy to create your own micro economy in which liquidity is always available — when and where it is required — then why didn’t this concept outcompete the often exploitative credit practices commonplace in traditional finance?
Well, with all its obvious benefits, mutual credit comes with a few drawbacks that have so far complicated its growth and adoption. Addressing these shortcomings is the whole raison d'etre of the ReSource project. What these shortcomings are and how we at ReSource use DLT and DeFi mechanisms to address them will be discussed in our upcoming post.
See you there!
Your Friends at ReSource.