The next money upgrade

From paper money, to digital money, to programmable money--unlocking a new era

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Dear Crypto Natives,

We often talk about the essence of money on Bankless—it’s trust guarantees.

We talk less about the medium of money. But money is a product and has features.

Why did paper money beat commodity metals? The convenience of storage and ease of denomination was surely a factor. Paper money was a better technology in some ways.

Both fiat and commodity money can exist in different mediums. Paper is one, digital is another, and now we’ve unlocked a new money upgrade—programmable money.

Kenny thinks this will change everything.

- RSA


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THURSDAY THOUGHT

The next money upgrade

Guest post: Kenny White, founder Cowri Labs building the Shell Protocol.

Killing the gold standard was the best thing that happened to money. We all owe Richard Nixon a heartfelt thank you for ending Bretton Woods in 1971. “Tricky Dick” ushered us into a new era. Until that point in human history, money was tied to a tangible asset. First it was shells, then it was gold, then it was paper backed by gold. With the stroke of a pen Nixon created fiat currency: money backed by nothing.

(Above) Did Nixon’s actions in 1971 help lead to the invention of cryptocurrency?

I know lauding the demise of the gold standard may upset Bitcoin maximalists, but consider this: without fiat we never would have had Bitcoin. With fiat, money as an abstract technology came into its own. And once an abstract concept, money became programmable. Cryptocurrency, a natural implementation of programmable money, is the next step. 

Digital money is not programmable money

Now some of you may be thinking, didn’t we already have digital money before cryptocurrency? When I open my banking app, pixels on my screen light up and show me my “balance”. On the back end this information and logic exist as 1’s and 0’s stored on a piece of silicon. That sounds pretty abstract.

The thing is, digital money is not programmable money. Currently, money exists as an entry in an ad hoc confederation of private ledgers our society refers to as “the banking system”. The banking system is replete with unnecessary redundancy and a commensurate level of inefficiency. Although the legacy system is electronic, it merely digitizes a process that was designed during a time when money was explicitly tied to a physical asset, gold. Banks stored the gold in their vaults and rather than physically settle every transaction with hard currency, they kept track of transactions on their ledgers, netting out inflows and outflows.

(Above) Our current digital money system is designed with the old paradigm—no programmability!


This kind of coordination is complicated. Digital bank accounts have essentially taken the process that existed a century ago and implemented it in software. No small feat. It is a miracle that my Visa card issued by a small US bank still works in a place like rural Tajikistan. The success of companies like Visa, Stripe, PayPal etc show just how hard it is to interface with the legacy system. And their healthy profits show how much we are willing to pay for the added convenience. 

What if we started over?

If we started out with an internet-first approach, money would look nothing like the current banking system. Not even close. Money, both fiat and hard money, would exist on a public blockchain, accessible to all anyone with an internet connection and inherently programmable.

The next upgrade is programmable money

I’ve been using this phrase, “programmable” a lot, but haven’t yet defined it. Money is programmable if it can be invoked as a simple software primitive natively integrated into smart contracts.

If you are an avid reader of Bankless (and you all should be, it is a fantastic resource!) then you are probably familiar with the concept of “money legos”. Money legos are the building blocks of decentralized finance (DeFi). Programmable money is the atomic unit of money legos.

If you think this is about faster settlement time, or borderless payments, it goes much deeper than that. Ultimately, this is a story about complexity. With programmable money, financial arrangements can become arbitrarily complex, limited only by the performance of micro-processors.

Brief History of Money Upgrades

To truly appreciate the implications of this, it behooves us to consider past money upgrades and how they transformed society. 

The Paper money upgrade

The end of Bretton Woods was the culmination of a process that began in 8th century Tang China, when people realized that paper could be used as a symbolic representation of gold stored in a vault. The benefits of paper over physical gold are obvious. Paper is lighter, easier to carry, easier to count. These attributes dramatically reduced the costs of financial complexity. Assets could be moved around by manipulating ink on parchment. 

(Above) Yuan dynasty printing plate & banknote—paper money was one of the first money upgrades

Paper money unlocked several financial innovations but I want to focus on two of the most important: bonds and stocks. The earliest bonds originated in Renaissance Italy around the thirteenth century. Investors would buy pieces of paper (bonds) that promised to make a set amount of payments in the future. This turned out to be a great way to aggregate capital in a society and channel it toward productive uses. 

Stocks were yet another crucial innovation enabled by paper currency. Joint stock companies were pioneered by the English and the Dutch in the 16th century. Investors would purchase pieces of paper that gave them proportional ownership of a fictitious entity called a “company”. Investors get the upside of the company’s profits. Not only were these ownership shares tradable in secondhand markets, similar to bonds, joint stock companies are a great way to align the incentives of multiple parties to cooperate on lucrative but risky projects.

All of these innovations required exchanging one form of paper (money) for another form of paper (financial instruments). If paper did not have value, none of this would be possible. Furthermore, because bonds and stocks existed as pieces of paper, they could then be traded in secondhand markets, opening a whole new avenue of financialization. No longer does an investor need a direct, personal relationship with the investor. They can simply purchase the stock or the bond second hand.

(Above) A paper bond from the Dutch East India Company 1623—among first publicly issued bonds

When the cost of financial complexity goes down, we create new forms of commerce, and these new forms of commerce radically transform society. Stocks and bonds literally underwrote the industrial revolution. Major feats of engineering such as railroads, factories and steam engines would not be possible without some way for society to coordinate surplus resources from one sector to another, from one time interval to another. If it weren’t for paper money, we would still be relying on subsistence agriculture.

The programmable money upgrade

We are living through another historical inflection point, except we are progressing much, much more rapidly, so buckle your seat belts. To get an inkling of how programmable money is upgrading the level of financial complexity, look no further than the DeFi movement. 

A new revolution in financial complexity is happening before our eyes. We have lending pools such as Compound and Aave. These protocols allow people to pool their tokens together and loan them out, earning interest. This interest is captured by yet another token that can be traded secondhand (“cTokens” and “aTokens”). In essence, these lending pools are like legacy money markets, except they are distilled into a programmable money lego which can be composed with other DeFi protocols.

For example, Staked has a protocol that dynamically deposits and withdraws tokens into/from lending pools, seeking the highest yield. Called “Robo Advisor for Yield”or RAY, it is a protocol built on top of protocols built on top of programmable money.

Another promising area of rapid innovation are liquidity pools powered by automated market makers (AMMs). The canonical example is Uniswap v1. Liquidity providers pool two or more tokens together into a smart contract. This smart contract has logic that enables it to trade autonomously with the rest of the market, earning fees for liquidity providers in the process. Liquidity pools are an amazing money lego. They provide reliable, on-demand liquidity that is easily composable with other protocols. For example, DeFi Zap (see tactic #25) could use Uniswap to automatically convert ETH into Dai/USDC to be deposited into Compound. 

The growing complexity of DeFi protocols has created a need for decentralized portfolio management. PieDAO is a governance layer for users to come together and engage in a collective investment strategy, perhaps not too unlike ETFs and mutual funds in legacy markets. Rather than manage a complex portfolio yourself, you can buy into a PieDAO portfolio.

Simple primitives to build sophisticated financial instruments

Let me give you an example of how each of these three money legos, lending pools, liquidity pools and governance layers, can be synthesized into a complex financial instrument.

Start with a liquidity pool for token A and token B. Instead of holding vanilla A and B, why don’t we have the pool’s smart contract deposit its idle tokens into a lending pool and earn extra interest? When the AMM needs to make a trade, we can withdraw and deposit tokens from the lending pool ad hoc. That way, the liquidity pool can still facilitate trades while storing idle capital in an interest bearing lending pool. Furthermore, this liquidity pool could be governed by a DAO, which allows it to adapt to new conditions and circumstances. The DAO can decide to add a new token, C, to the pool. Or it can move its reserves to a new lending pool. Perhaps it wants to switch from Compound to RAY?

In my mind, this is just the tip of the iceberg. In late 2018, lending pools and liquidity pools were largely hypothetical with only a few examples out in the wild. Imagine what will come about five years from now? The technology is in its alpha stage and is already capable of behaviors and complexity the legacy system hasn’t even contemplated.

(Above) Interacting protocols create emergent financial superstructures like Conway’s game of life

These examples from DeFi show us that programmable money enables new complex financial instruments. These instruments themselves are also programmable and can be composed together to create increasingly complex instruments. On top of all this, the inherently open nature of public blockchains means that anyone can access this new ecosystem.

The benefit of programmable money?

Why would regular people want or benefit from accessing such financial complexity? This is a little bit like asking why people would want or benefit from having a super computer in their pocket. The iPhones of today are many times more powerful than the computers NASA used to travel to the moon. The financial instruments accessible to regular people will be many times more complex than what exists today on Wall Street.

And this is not just an end-user story. Perhaps the real story is that developers can take advantage of these new money legos and integrate them into their applications and products.

For example, a friend of mine has a mango farm in Ghana. One of her big pain points is the volatility of mango prices on the global market. In the future, apps that enable hedging mango prices via futures and options will be trivially easy and something that even small businesses can do. This may sound speculative, but we are already heading down this path. Protocols like Opyn and Futureswap allow users to buy and trade these derivatives on a decentralized market. It is only a matter of time until these protocols are incorporated into new money legos that will eventually power user-facing applications on the back end.

“But this stuff is still too complicated”

Kenny, you say, how could small businesses hope to understand something as complicated as futures and options? Forty years ago, using a computer was quite difficult, far beyond the average small business owner. Fast forward to 2020, and virtually every business runs on a computer. What happened? Two things: computer literacy went up. And, crucially, computers became a lot easier to use. The same thing will happen for novel financial instruments. Hedging the price of mangoes will one day be as trivial as joining a Zoom call (which admittedly isn’t that easy).

I won’t try to predict how society will change—too many second order effects at play. However, it seems clear that if anyone in the world has direct access to sophisticated financial tools that are far more complex than what legacy financiers use today… the world will radically, radically change.


Navigating the bottlenecks

Trying to imagine the future of human commerce at this point is a bit like Renaissance merchants in Florence trying to visualize Standard Oil. However, I can try to anticipate potential bottlenecks.

Here’s one—if blockchains don’t scale, the programmable money revolution will stall. I am by no means an expert in base layer protocols, but it seems like ETH2.0 is making progress and if not there are alternatives like Cosmos and Harmony waiting in the wings. 

Another bottleneck could be regulation. It is the perennial bugaboo of the crypto industry. While unfavorable regulation could definitely harm short term progress, bureaucrats can’t stop the revolution. Indeed the legacy interests are quite powerful, but so were European monarchs and the Church. Change is inevitable. Polities that fail to adopt the new system will languish just as surely as those that spurned industrialization.

There is, however, one bottleneck that people are not really talking about. Stablecoins are the backbone of DeFi. Without stable assets to use as a store of value, medium of exchange and unit of account, the ecosystem cannot function. 

In DeFi, there are only a handful of stablecoins widely used: Dai, USDC and Tether. Ironically, the US banking system is more diversified than decentralized finance. If we care about resiliency, then we shouldn’t have any stablecoins that are too big to fail. Simply adding more stablecoins, however, won’t solve the problem. Even with the few stablecoins currently in circulation, the market is highly fragmented with liquidity diluted across each currency. 

What we need is a protocol that can unify stablecoins into one coherent monetary system, a stablecoin interoperability protocol. This protocol should not only bring liquidity between stablecoins. It should incentivize the creation and adoption of new stablecoins. Finance is like a rainforest, bio-diversity makes the entire ecosystem thrive. (My project, the Shell Protocol, is trying to solve this problem. Our goal is to create a stable and liquid medium of exchange accessible to anyone on the internet.)

Final thoughts…

It is quite fortunate that programmable money is coming into its own sooner rather than later. Even before the global pandemic and ensuing lock down, the economy was on loose footing. In 2019, the Federal Reserve made the unprecedented move to intervene directly in the repo market, which is like the low-level plumbing of the financial system. With other crazy phenomena happening, such as oil prices dropping to negative territory, we may be entering the end-game for the legacy system. The world may be in need of a life raft sooner than we think...


Author bio

Kenny White is the founder and chief economist at Cowri Labs, building the Shell Protocol.


Action steps

  • Consider—how will programmable money improve our financial system?


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Not financial or tax advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This newsletter is not tax advice. Talk to your accountant. Do your own research.


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