Hello again! This is the first official installment of my new experiment. Read chapter 0 here: https://acuna.eth.limo/2022/a-new-experiment/

Today, I’ll write about risk, time, and value. 🤑

It’s amazing how little we know about our financial systems. Specially the underlying assumptions, models, and unwritten rules that govern them. Maybe they’re so ingrained in our society that we just take them for granted?

Back when I was at Cumplo I thought I understood some of those assumptions. I would actually teach a short “class” based on them to our newest colleagues. Now I realize I wasn’t asking enough questions, because some concepts just seemed obvious, logical, or rational.

Let’s start with the cumplo notions and see if they hold their ground.

If I offered you 1,000 dollars, when would you want them, today or in a year from now?

If you’re a modern human, you’d say “today”!

Now, how much more would I need to offer in a year for you to accept it? 1,050? 1,200? 2,000?

If you decide you trust me, and you think like my finance professor, you would say “as much as a ‘risk free’ investment would pay”, whatever that means. If you don’t trust me, you’d probably demand a higher premium, according to my perceived “risk”.

“And that, kids, is why interest is charged when lending money. There is a risk involved, which gets quantified in the rate being charged. Guillermo is risky, so charge him at least 50% annually.” That’s as far as I used to take my intro to lending.

It makes sense, or at least we’ve been told it does. Money today is worth more than money tomorrow because we could do things with the money in the meantime and/or there is a risk we won’t get the money in the future.

But, does it really make sense? Underlying this is the notion money needs to always grow and that you can actually somehow quantify your trust in someone. It also assumes there is a way to have access to a risk-free investment. Furthermore, I would argue it also assumes you have a legal recourse in case you’re not paid.

Let’s go back to my initial offer, but now I’m willing to sign an IOU. Would my rate go lower? What if I offer my house (if I had one) as colateral? In many places, a house is worth more than 1,000 dollars. This should make my “risk” irrelevant, as long as there is a way to enforce that promise. In most cases, it doesn’t…

In many countries, there are laws governing private property and commercial transactions. Not fulfilling your commitments entitles your counterpart to sue you, they have a legal recourse. Even if you don’t explicitly leave a collateral, they’re usually entitled to seize your known assets. If it weren’t for those laws, and a nation-state enforcing them, IOUs and collaterals would be irrelevant. I could essentially promise anything, without more consequence than damaging my reputation.

What would happen if those commitments were not enforceable or states decided it wasn’t their job to mediate such matters? They could say “you say you’re good at assessing risk, you don’t need us.” (In reality, we all know we suck at quantifying risk.)

In medieval times Islamic states did just that. Furthermore, Islam made charging interest rates forbidden. God, they argued, had created money for the explicit purpose of governing and facilitating transactions, so creating money out of money was a sin. All transactions became equity transactions and people’s greatest asset was their reputation. Agreements required nothing more than a handshake and the state was effectively left outside the markets.

Beyond current and historical markets, what happens if we have programmatically enforceable contracts? Do we still need a third party to enforce them? To measure risk? To mediate? How will those tools change how we transact? If I wrote a smart contract that would let you choose between 1,000 USD today or 1,000 in a year, no questions asked, would it change your choice? What if the money were put into a liquidity pool, earning fees from trades through a decentralized exchange? Any day that passes would mean you get more money.

On the other hand, how do we determine if a contract is fair? Going back to the original 1,000 dollar offer and leaving my house as collateral, would it be fair for me? I was willingly signing the contract, right? We’re equal parties in the transaction, right? Is a loan from a bank to a person a contract between peers? How do we move to more humane transactions? It’s easy to abstract someone into an interest rate, which makes it easier to act in unfair ways. How does it change when we use a medium that doesn’t allow us to be unfair?

Finally, how would everything change if we suddenly agreed that money doesn’t need to grow constantly? What if we agreed to try to prioritize other things? Or if we simply decided to engage only in equity transactions, in which all partners engage in the same risk?

So many questions, so many ways of doing things, and yet, so many unexplored paths. We haven’t seen a fundamentally different way of doing things in a long long LONG time. Maybe crytptos and blockchains change that? I don’t know, I only know I have more questions than answers at this point.

See you next time for more random thoughts, unanswered questions, ramblings, and hopefully some entertainment. This particular rambling was largely inspired by “Debt: the first 5,000 years” by David Graeber.