My word is my bond.
There's a lot of confusion about the financial system. In a lot of ways the banking sector in particular is confusing on purpose because the ultimate professional goal of most bankers is to trick others into taking a bad deal and pocketing the difference. Of course the main tool in the chest is interest rates, but there's also an entire derivatives game to be aware of.
Debt is a pretty straightforward concept up to a certain point. Like many liquidity markets: it is an arrangement between a maker and a taker. The maker is the person with the money; the lender. The maker lends to to the taker who is also the borrower. Both sides get what they want. The maker will get paid back with interest at a later date (hopefully) and the taker gets liquidity today that they can use today for whatever reason.
Almost every business requires a loan to bootstrap itself off the ground. Many of them will straight up allow themselves to be bought by a parent company just so they can scale up. The overhead cost of such things is quite high.
When the loan is being used as an investment, the borrower is making a bet that they can turn a profit that is greater than the interest rate on the debt. In essence what they are doing is "going long" on their investment, which in this case is a business, but could be anything.
However, debt becomes very confusing once we realize that every fiat note (dollar) in the economy is actually just debt. This is confusing because we can own the debt. Owning debt doesn't feel like debt; it feels like owning money.
When citizens hold a dollar in their hand they don't feel as if they own debt (a promise). They feel like they're holding raw value because that's how they treat this asset as an end-user. As we all know the end-user of a product very rarely understands how that product works. It's much easier to use a computer, car, or house than it is to understand how they work or how to build one. Money and debt are no different.
Collateral is the foundation of all debt; without exception. It is not possible to create debt without collateral. Again, this is very confusing because "collateral" can mean a lot of things. In fact, the very core of collateral is trust. We trust the collateral to have an "intrinsic value".
Reputation is up there at the tippy top because it applies to everything. Everything else is a subset of reputation. A person's promise to pay back the loan is covered by reputation, but also the value of an asset like a car or gold also has a reputation. Those assets have a reputation and a history of acting as collateral.
Most debt is secured by collateral that can be repossessed by the lender should the debt not be repaid. This is called a secured loan. If we don't make our car payments they take our car. If we don't make our mortgage payment they take our house. Same for businesses themselves.
Secured loans are safer for the lender (bank) because if all goes tits up they can at least procure the collateral and sell it to mitigate the loss. This is why banks are willing to loan a lot more money out to people when that debt is backed by "pristine" collateral. The idea behind the word "pristine" here is that the underlying collateral isn't going to suddenly flash crash in value which would leave the lender with more risk than they intended (which is why crypto is such a dangerous form of collateral in the short term).
The existence of unsecured debt is a direct result of the fact that slavery is illegal. If slavery was legal there would be no such thing as unsecured debt because the person in debt could be taken and owned as collateral for the unpaid sum.
Unsecured debt means the bank just has to trust the person based on their credit score and history. Credit cards are the most classic example of unsecured debt. The interest rates on these loans have to be much higher than secured debt to sweeten the deal because the risk is higher to the lender.
The most ironic part of all of this is that money in the bank is unsecured. Meaning bankers have decided that legally anyone who deposits their fiat into a bank no longer owns that debt. The bank owns it. "Money in the bank" is unsecured, meaning it's not backed by collateral within the fractional reserve system... even though in many instances fiat absolutely is used as collateral: that is not the case on a legal level when citizens employ banks as custodians.
* Debt (recursive/nested trust)
Yep at some point bankers realized that debt itself has a reputation and can be used as collateral. We can think of this as a promise of a promise. The borrower promises to pay back the loan and the collateral itself has also been promised by another entity. Another way to think of this is that the collateral is a derivative of a promise.
A good example of this would be shorting any asset in the stock market or crypto. When we short we are holding USD as collateral and hoping that the price of the thing we borrowed (crypto/stock) goes down so that we can pay back that debt at a cheaper price. If we are wrong the lender gets our USD, which is a promise back to the retail bank that issued it.
Another good example of this would be bonds. A bond is like a reverse loan. Instead of a citizen asking for a loan, an institution like a government, bank, or corporation is asking for a loan from the citizen. The institution takes the citizen's money and provides them with a promise to pay it back with interest. This promise is called a bond. Thus, bonds are debt derivatives issued by "high reputation" institutions.
Because bonds can also be used as collateral. This means that it is a derivative of a derivative of a derivative. The bond holder promises to pay back their debt secured by the bond. The bond promises to pay back their debt to the bond holder, and the USD that created the bond is promised back to a commercial bank.
If all of this sounds highly suspect and unsustainable, that's because it is. There is no limit to how many derivatives of derivatives of derivatives can be made. There is no cap on the degeneracy of the bankers. They'll keep doing it until the entire system collapses and laws are put in place to stop them from doing it... which has already happened several times now... and every time it does the burden of that failure is put on the citizens while the "too big to fail" banks get bailed out and continue failing upward. Fail.
Remember how I said USD is a promise back to the bank? Well then what about USD itself? How is that created? Well USD is a promise back to the Federal Reserve. So what is the collateral for USD? They are the reserves at the FED. And what are those reserves printed from? 100+ years ago it used to be they were printed from gold, but now they are printed out of thin air on a promise from the FED. So essentially the entire thing starts with a promise from a privately owned institution. Not great.
The funny part? We call this "pristine collateral" because bonds have a long-standing history. Many secured loans are much much worse than this. Yeah well the music is going to stop eventually because it's all completely ridiculous.
Our stable coin is very interesting because... what is it? Is it a derivative of USD because the unit-of-account is pegged to dollars? Or is it a derivative of Hive because when the peg breaks to the downside Hive is minted out of thin air to prop it back up? The answer is complicated.
It's a bit of both but mostly HBD is a Hive derivative. If USD started hyperinflating and pushing down the value of HBD we could negate that loss by jacking up our own interest rate. It's also possible to hardfork to a different asset and peg HBD to something else (although what would we peg it to if USD was failing?). The buyer of last resort for HBD in HIVE, which makes HBD a derivative of the HIVE network.
The thing that makes crypto very interesting is that it is collateral at the core. When Bitcoin gets minted it is owed back to no one. Same with Hive and most other cryptocurrencies. In fact, even HBD is this way. HBD is owed back to no one whereas USD is owed back to the bank with interest. This is a huge difference that we have yet to fully understand and capitalize on.
An idea to increase timelocks on the savings accounts and create bonds with HBD has been talked about for quite some time now. The more I think about it the more of a terrible idea I'm convinced it is. Crypto was invented to think outside the box and get away from unsustainable derivatives. So our solution is to just ignore all that and try to recreate the same broken Jerry-rigged system? No thanks. We don't need more derivatives we just need more liquidity (aka AMM HIVE/HBD). But I digress, as I've explained why a dozen times over already in previous posts.
Fiat is debt. The only question is: who owns the debt? If you own the debt you're the lender (maker). If you owe the debt you're the borrower (taker). Earning USD means earning debt. Your paycheck is debt. The money in your bank is an unsecured loan that you can't get back if the bank fails. All derivatives are debt secured by reputation and promises. It's all very confusing and nonsensical, just the way bankers like it. That's how they make their money.
Crypto is the first asset since gold that's able to break away from this model. The difference with crypto is that as it evolves it will start to become superior in every way to the alternatives. This is a waiting game. Be patient.
However, the main takeaway from all of this is that all debt is based solely on collateral. Without collateral: debt can not exist. If crypto is primed to become the best collateral the world has ever seen by exponential margins... well then what does mean in relation to debt?
The ultimate conclusion to be made is that crypto will allow debt to become more ridiculous, not less. Better collateral equates to better debt... until the people creating the debt realize they can keep diluting it with a copy of a copy of a copy of the original underlying trust that was used to create it. If I am a drug dealer and I have the world's purest cocaine... that just means I can step on my product even harder to turn a bigger profit.
