I had this idea and wanted to share it generally. I hope someone will run with it, or that it will at least plant seed for discussion of this and other potential uses for the Ethereum blockchain.
Tl;dr: Make a global system of recording title, issuing loans, securitizing loans, and enforcing loans all using the Ethereum blockchain; decentralize the credit markets to increase profits to holders of debt pool securities, increase recovery from default, and open credit markets to currently underserved areas, such as developing countries.
Global Decentralized System for Securitizing Collateral Debt Obligations Using the Ethereum Blockchain
By _ETHeREAL_The concept:
The idea is to come up with a cross-border, decentralized, transparent, and more secure system for issuing loans to consumers, securitizing loan pools, and efficiently enforcing collateral obligations in default (and efficiently liquidating collateral). Each piece benefits a great deal from decentralization and recordation on the Ethereum blockchain and the programmatic contracts made possible by Ethereum. You can represent and programmatically implement things like creditworthiness determinations, collateral title recordation, collateral liquidation, loan pooling and even securitizing loan pools very efficiently with the Ethereum block chain.
Forming the securitized loan pool: The first step is to form a securitized loan pool. A series of shares of a stake in a pool would be sold in exchange for an upfront payment. Each share will entitle the holder to automatically receive a portion of the pool’s income. Loan pools could be formed with various goals balancing risk and return. Pools could programmatically determine how much to hold in reserve versus periodic payout (i.e., 5% of income could be held in the pool to increase the loan pool over time). All of the terms, goals, size, risk/return would all be transparent and decentralized through an Ethereum-based contract recorded on the blockchain. Once the pool is formed, it can begin issuing loans and collecting payments, all using Ethereum-based contracts and value represented on the Ethereum blockchain. Loan Issuance and collateral title recordation:
The first step in loan issuance is programmatically setting loan terms based on collateral valuation and/or creditworthiness determination. Creditworthiness is currently a highly centralized and geographically limited system – think of the benefits obtainable from tracking and representing creditworthiness using the blockchain. It would open the system to anyone, regardless of where they are and what currency they use. Currently, a very large portion of the world outside of developed countries do not have efficient access to credit markets, and often may have no access at all. Profit potential from tapping that market with securitized debt obligations is huge and would bring much needed capital where it is needed most. The potential from unseating market share from current controllers of the credit markets is also huge – increasing credit market efficiency and decentralizing it will return more profit to the holders of securitized debt obligations.
Loan issuance could take into account creditworthiness representable on the blockchain, which could be determined by any method, so long as everyone knows what it is and can assess it. A credit score system using information on the blockchain or by consensus from stake holders are both possibilities.
Collateral title recordation and valuation would also benefit from decentralization with the blockchain. The blockchain is an ideal vehicle for recording title of just about anything from real property, automobiles, literally anything. When currency transactions are recorded on the blockchain, purchases could be securely recorded and provide a proof of ownership; this will likely help in the case of small or micro loans (an important growth area for the credit markets globally that will make it possible to profit from developing countries without current access to credit markets and where loans are currently exorbitantly expensive).
Valuation of collateral for the purposes of loan issuance could be generated by consensus or proportional vote by holders of the a specific pool of securitized debt obligations representing the pool from which the loan would issue; those people will have an incentive to properly value the collateral. For example, consider a loan for a used car secured with the car itself(too high and the loan won’t issue, or will go to a competing pool, and too low and the pool takes too much of a loss in the event of default). Alternatively, if valuation could be performed programmatically or objectively, then the system would be even more efficient. Once the loan issues against collateral where title in the collateral can be recorded on the blockchain, things like finding liens against the collateral and securing/liquidating collateral becomes efficient and transparent.
By whatever method used to value the loan, between creditworthiness and collateral obligations, loan terms could be determined programmatically. The loan would issue from a specific pool, where pools could be aimed at different risk levels that are associated with better or worse interest rate terms. For example, a pool could be aimed at earning a rate of income at high risk, and generally require low collateral Loan Enforcement:
One of the key efficiency benefits made possible by title recordation on the blockchain is efficiently handling loan payment and default. Whenever a loan payment comes in, the Ethereum contract programmatically distributes the payment (or does with it whatever the contract backing the loan pool security says to do).
Because collateral title is recorded on the blockchain, in the event of default, title automatically reverts to the pool. Government regulation of the credit markets is of course an impediment to using this system for things like mortgages in the near terms, but avoiding regulation and/or entering non-regulated markets is possible. In time, title recordation will be done using some blockchain, I am confident of that, but a universal system probably far off. The system described here does not need to be universal to be valuable, it just has to have some aspect of recordation of title representable on the blockchain.
Holding title on the blockchain also allows for efficient and programmatic liquidation of collateral to quickly return the underlying value to the loan pool. For example, the loan contract could programmatically promote and hold an auction for the collateral property, hold the auction, and both instantly transfer title to the new owner and take payment, which would be returned to the pool. This is a huge efficiency benefit. Debt enforcement (i.e., repo men) of physical property could be transparent and decentralized – debt enforcement services could even programmatically also bid on securing and physically transferring the property, the cost of which could come out of the return to the pool or be levied against the defaulter.
Default could reduce someone’s creditworthiness, of course, but if a remaining obligation exists, and the loan terms originally allowed for it, a remaining debt to the pool over the value recovered from liquidated collateral, could be leveraged against the defaulting loan recipient against currency or other value recorded on the blockchain. Of course, draconian consequences for loan default are possible, such is the reality today, and one would hope the market efficiency improvement would at least improve conditions. Debt pool securities:
One of the biggest innovations to the credit markets of the last century was the securitization of debt obligations and the development of all the myriad derivatives one can see in the market today. All of these types of products are possible on Ethereum and would benefit from decentralization on the blockchain. Starting the pool with value provided by selling debt obligation securities removes the need for a centralized banking system to be involved to hold a starting pool of capital (or to make money from debt issuance).
In fact, perhaps most importantly, this system obviates the need for a fractional reserve system where money is debt, and new debt issuance effectively is the means by which money is created by banks. Using crypto-graphic currencies that are created by mining obviate the need for issuance of money as debt and focuses money generation on transactions. This decentralizes the monetary system, which is a benefit and a goal I’m sure I don’t need to explain to anyone here to read this. A final thought on practicality
: For what it’s worth, and I’m sure various purists will not agree, I also believe that globalization and cross-currency loans would benefit from using something like the Ripple Network, at least at early stages where adoption is slow. I tend to think representing and transferring value using cypto-currency is important, but fiat will not disappear any time soon, and so facing that reality and leveraging the most efficient ways of using fiat with crypto-currency will improve adoption, e.g., issuing loans in fiat would likely help speed adoption. And, getting traditional banking institutions entrenched with fiat to use Ethereum will also be important to early growth, and using Ripple to bridge an Ethereum-based crypto currency and fiat should be possible, and while it introduces inefficiencies and reduces the decentralization but may be pragmatic at first because, ultimately, we need to spread adoption.