I'm going to assume you know about the DAO now. That is the 'Decentralised Autonomous Organisation'. If you don't start your journey down the rabbit-hole here.
The DAO is a fascinating concept and anyone tinkering in the blockchain space will have considered it. It's the extreme conclusion of an ever more decentralised and automated organisation to perform commercial or public services on a blockchain. Think of it as a series of smart contracts interacting on a blockchain to perform all of the interconnected functions of an organisation.
PUTTING THE LIMITATIONS OF THE VARIOUS INCARNATIONS OF THE DAO AS IT IS TODAY ASIDE I WANT TO EXPLORE HOW FAR WE CAN STRETCH THE CONCEPT TO FUTURE APPLICATIONS.
The thought exercise is to apply the concept:
where centralised systems are either ineffective, inefficient or corrupted.
Whilst FIFA would be fun :) I thought we would look at something slightly more important to our lives such as the major quantitative easing programs implemented by central banks. Whilst there have been trillions pumped into the system by The Fed and The European Central Bank alike the debate around approach and results differ. So to avoid getting stuck in the nuances of each I will focus on the £375bn+ created by The Bank of England in my home country where I have had the most direct experience.
To be clear this is a personal line of thinking and not tied to any investments. The purpose of the post is to take the DAO debate to the next level not the politics of monetary policy itself.
First let's just recap on some of the benefits of a DAO. In many cases they are inextricably linked to the benefits of smart contracts and distributed ledgers only in aggregate:
- Automated. Any number of processes can be entirely or part automated including the allocation of a pool of capital without an intermediary bank or other 3rd party
- Efficiencies. By removing unnecessary intermediaries, and their costs, systems can become more efficient.
- Governance hardcoded. Rules are embedded into smart contracts that govern the system. Ensuring all parties in that system are incorruptibly and auditably honest
- Compartmentalised. Each function in a DAO is an independent smart contract which can have its own unique permissions without risking the integrity of the entire system.
- Integrated. An entirely 'on chain' movement of funds between numerous parties using one single operating system. Including the lending and use of funds as well as revenue sharing, repayments of loans and profit sharing.
Now I think we can take the DAO one step further, which is what is actually being proposed in The DAO project if you follow it to its conclusion, which is DAMs (Decentralised Autonomous Markets). That is a system of exchange between two or more DAOs on the same or connected blockchains.
Quantitative Easing
'Quantitative easing (QE) is a monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective. A central bank implements quantitative easing by buying financial assets from commercial banks and other financial institutions, thus raising the prices of those financial assets and lowering their yield, while simultaneously increasing the money supply'. (wikipedia)
At least that’s the idea.
Basically the role of a central bank is to control the supply of money in a given economy. It usually does this by raising or lowering the overnight interest rates it charges banks to hold their money. If firms were growing nervous about the future and scaling back on investment, the central bank would reduce the overnight rate. That would reduce banks' funding costs and encourage them to make more loans, keeping the economy from falling into recession. However when interest rates get to zero, or in some cases negative such as Bank of Japan and the European Central Bank, it is no longer an effective tool.
So banks begin to do QE. They create money by buying securities, such as government bonds, from banks, with electronic cash that did not exist before. The new money swells the size of bank reserves in the economy by the quantity of assets purchased hence the name "quantitative" easing. Like lowering interest rates, QE is supposed to stimulate the economy by encouraging banks to make more loans.
What is supposed to happen:
It depends on the approach and nuances of the given economy. But in most cases central banks hope this cheap money encourages banks to lend more to both small businesses and consumers. In turn giving them the confidence to spend more stimulating greater economic activity.
What we ‘think’ actually happens:
Firstly some think the success levels of QE have been different in the US compared to the EU because Americans hold more of their wealth in stocks and shares which tend to go up as a consequence of the below activities. Equally in the UK it could be argued homeowners have benefited as prices have gone up. For sure it has an effect but let’s start with the assumption QE in our case is supposed to stimulate banks to lend more directly to consumers and SMEs rather than possible indirect benefits of QE which could be the value of your stocks or home go up should you own either.
Then back to our starting question: is this ineffective, inefficient or corrupted and therefore could it be significantly improved by a DAO type instrument?
Some concerns:
- Money piles up in the bank’s balance sheet who don’t always lend significantly more to consumers or small businesses where it's needed.
- It can generally feed into lower bond market rates for large successful corporations, how they finance their businesses, who could already borrow cheaply anyway
- It has been shown to lead to those large corporates paying themselves more dividends or increasing M&A activity (mergers and acquisitions) creating ever greater market consolidation thereby putting greater pressure SMEs
- Worse still, there is no way to control geographically where the money can be invested by these multinationals once it enters the system but it can be spent on overseas not domestic speculation.
I say ‘think’ because the reality is no one, as far as I can see not even the central bank, knows how effective it is. However almost everyone acknowledges is it is a very indirect and inefficient way of lending to consumers or SMEs whilst it definitely has the consequence of benefiting large multi-nationals and banks. Those in the US say this benefits those that hold their stocks & shares but as previously discussed this is not so true in places like Europe.
Could a DAO type instrument be more effective?
Some disillusioned with QE have mooted the idea of a ‘national investment bank’ or trying to find a more direct and effective way of stimulating a given economy. I believe a DAO potentially offers such a method. Here's how:
- A given central bank sets up a blockchain in which transactions are processed by proof-of-stake by a handful of regulated entities at fixed rates.
- The central bank issues digital money, this time as cryptocurrency, on the blockchain pegged to its own fiat currency to avoid any additional volatility
- The money is held in a DAO setup to replace the QE process and lend via a network of intermediary DAOs we shall call ‘brokers’.
- All DAOs in the process are legal entities within the local jurisdiction and all agreements enforceable by law
- The Central Bank DAO serves as an escrow with clear rules and voting rights about how the money can be distributed based on a tendering process.
- A series of RFPs (request for proposals) are created by the central bank and published on the blockchain aligned with stimulating lending to certain groups of businesses or consumers within fixed lending criteria.
- Authorised, likely regulated entities, drawn from the Alt Finance community can submit proposals about how they, as 'brokers', would best get funds to a given borrower group efficiently and effectively
- The catch is they must achieve this within a DAM by building DApps (decentralised applications) on the central bank's permissioned ledger. All key processes must be governed by smart contracts in a fully auditable way. Possibly even in real-time with the lending criteria hardcoded.
- Proposals by brokers are reviewed by an elected panel who vote, again in a fully auditable and transparent way, and lumps of money are released into associated smart contract escrows on the central bank's blockchain (Who has the right to vote I don’t offer here).
- Money is drip fed, based on the success of a brokered their loans, with a fixed commission taken at both ends of the transaction: both the money being lent and the money being paid back. Underperformance triggers a review and depending on the vote loss of funds.
Wrap Up
Firstly I know some might question if this even counts as a DAO largely because it is not 100% decentralised and because I am proposing they will be legally constituted entities. I would argue this is the course of all DAOs if they wish to ever become mainstream and certainly deal with public money.
Many would argue DAOs should sit outside of the legal and banking systems. I think in some cases they will but I would argue, like blockchains more generally, they will be co-opted and if this example holds with good reason.
The likelihood is to implement something like this would be an enormous task and not one I would be in the remotest bit interested in managing. The task would be way too political and to be honest complex. But the purpose of the post is to take DAO thinking and the debate to the next level.
I would like to add the disclaimer: I am not an economist nor a banker so it’s entirely possible there are errors in my thinking around QE and approach. If you are and can offer additional insight please do I have also sought it in advance from my network before I posted. This is meant as a thought exercise rather than a proposal to the ECB!
