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Balance sheet operations of a cross-border settlement process with the use of XRP

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Posted (edited)
14 hours ago, tar said:

Not nothing - from their and their debtors assets/wealth (collateral). :victory:

Oooh, now you've done it :prankster2:. If I repo a derivative of another loan, which is based on someone's income--which I create, that sounds like a whole lot of nothing to me. A bank can choose to create a loan based on no collateral--they can give someone bank deposits if they want. 

 

Edited by Wandering_Dog

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1 minute ago, Wandering_Dog said:

Oooh, now you've done it. If I repo a derivative of another loan, which is based on someone's income--which I create, that sounds like a whole lot of nothing to me.

You do what? :JC_out_cold:

1 minute ago, Wandering_Dog said:

A bank can choose to create a loan based on no collateral--they can give someone bank deposits if they want.  

Which would lower the banks equity (net worth). There is no free lunch :bye:

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8 hours ago, Wandering_Dog said:

Can you give us an example of what you mean, or are thinking of, in a specific context?

Without wanting to re-open the debate above regarding debts/debits/liabilities or derail this thread, one area that jurists are looking at is how liability is apportioned for the various parties involved in a distributed ledger ecosystem such as xRapid and XRP.

At some point, the courts and regulators will need to decide in relation to transfers of value and breaches of promised transfers:

(A) which party in the network is liable and to whom they are liable;

(B) at what point in time a party is liable; and

(C) the extent of their duties, obligations and liability,

in a network of value where counterparty risk is allegedly being "eliminated" (see for example @Bagheera's oft-quoted thread: https://www.xrpchat.com/topic/6362-the-reason-why-xrp-will-be-adopted/).

The lawyer in me says you can't eliminate risk, only mitigate or shift it. However I've had to re-visit that and many other assumptions about how this will work in the future. If my old assumptions are wrong and the DLT is in fact eliminating counter-party risk (due to the nature of immutable, irreversible, unstoppable transfers of value offered by DLT) then we need a new way of looking at contracts, assets, debts and liabilities (and the appropriate accounting treatment of them).

If, on the other hand, the jurists are right and counter-party risk is simply shifted somewhere else, then the unlucky recipients of that risk (who???) will need to cost that risk into their operations (and pass it back to the end-users). The jurists will shoe-horn the messy stuff (such as self-enforcing contracts, prima facie illegal contracts, DAOs, loss of traditional contract remedies etc) into pre-existing formulas and fudge things so that the existing systems, terminology and definitions are maintained.

However both sides can't both be right (well, not unless the law develops theories of liability and risk akin to quantum theory). And this problem needs to be solved by anyone wishing to rely on terms such as contract, liability, debt, asset etc in this space.

To give one practical example of this, I've been of the view that Ripple's plan of eliminating its dominance on the UNL had at least a dual purpose: the first purpose was dealing with the optics of a single company having dominance over the validators (which contrary to widespread belief would actually have been considered an advantage for many larger customers of Ripple - "One throat to choke"). This has a sub-purpose of defending against the security themed litigation currently in play.

The second purpose hasn't been discussed: reducing dominance on the UNL was part of a wider de-risking strategy by Ripple. Transfers of value are no longer solely validated by them and therefore any losses suffered by users of XRP (through dumb contracts <_<, the IPL, escrows, IOUs etc, all of which are required to be cryptographically validated by the nodes) cannot be sheeted back to them alone. I say this because the emerging jurisprudence suggests that miners, validators, nodes and oracles will be a primary target for litigation in the future.

That's the current prediction, unless a jurist of the stature of Einstein comes along and develops a radical new way of approaching these questions.

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Posted (edited)

@KarmaCoverage @Wandering_Dog @jcdenton @BrownBear @hallwaymonitor

I've just updated my document again (v1.4) and made an important correction regarding the creation of the purchase order, the posting of the products value and the settlement description (and also replaced "liabilities" with "obligation") to be more precise on the legal perspective.

1 hour ago, Pablo said:

Without wanting to re-open the debate above regarding debts/debits/liabilities or derail this thread, one area that jurists are looking at is how liability is apportioned for the various parties involved in a distributed ledger ecosystem such as xRapid and XRP.

At some point, the courts and regulators will need to decide in relation to transfers of value and breaches of promised transfers:

(A) which party in the network is liable and to whom they are liable;

(B) at what point in time a party is liable; and

(C) the extent of their duties, obligations and liability,

in a network of value where counterparty risk is allegedly being "eliminated" (see for example @Bagheera's oft-quoted thread: https://www.xrpchat.com/topic/6362-the-reason-why-xrp-will-be-adopted/).

The lawyer in me says you can't eliminate risk, only mitigate or shift it. However I've had to re-visit that and many other assumptions about how this will work in the future. If my old assumptions are wrong and the DLT is in fact eliminating counter-party risk (due to the nature of immutable, irreversible, unstoppable transfers of value offered by DLT) then we need a new way of looking at contracts, assets, debts and liabilities (and the appropriate accounting treatment of them).

True and thats why I made the assumption of the creation of corresponding obligations before their settlement is atomically executed. This all happens within fractions of a second (or for XRP between 3 to 7 seconds, for now).

1 hour ago, Pablo said:

If, on the other hand, the jurists are right and counter-party risk is simply shifted somewhere else, then the unlucky recipients of that risk (who???) will need to cost that risk into their operations (and pass it back to the end-users). The jurists will shoe-horn the messy stuff (such as self-enforcing contracts, prima facie illegal contracts, DAOs, loss of traditional contract remedies etc) into pre-existing formulas and fudge things so that the existing systems, terminology and definitions are maintained.

For my example, the counterparty risk is not removed at all. The buyer, seller and both market makers have a counterparty risk as they use accounts at their corresponding commercial bank. From a banking perspective, there is no counterparty risk.

But furthermore, there is a volatility and/or spread risk at the market makers side which either could be eliminated by an instant buy/sell order before/after the XRP transfer or could simply be paid as fee by the initiating party of the overall settlement (which in my example would be B_usa which will forward the fee to its customer P_usa).

Additionaly, it depends on how you define a market maker - as he has to buy/sell XRP somewhere. Therefore, either he has to use an exchange where he has to have an account (counterparty risk) or he is the exchange himself (then I do only see a counterparty risk for the market maker at the banks account, as explained).

As you see, I talk about non-XRP-ledger risks. They all lie before or after the XRP ledger.

Edited by tar

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Posted (edited)
9 hours ago, tar said:

Which would lower the banks equity (net worth). There is no free lunch :bye:

The central bank can issue reserves without having any assets--in this case, (which I will finish, it's just taking a long time...:focus:), there is no collateral. 

Alternatively, as we have already agreed, you can base the initial gov outlay on the "implied asset" on the Treasury's balance sheet when the gov is created, which is equal to the PV of all future tax income. This tax income isn't required to pay anything, it is an idea that permits the system to maintain accounting consistency when we initiate it. We choose to impose that constraint on the system--you don't have to impose that as a starting condition, the system works the same without it.

On another note--let's say the US reduces it taxes to 0 tomorrow. Do US citizens stop using the USD? What would be the impact on demand for USD now that the system is already established?

Similarly, if someone asks me "why are stock prices increasing" and I respond "prices are all based on taxes", are we saying that literally the tax data explains prices with an R^2 of 1? Unlikely. And how helpful is the statement "prices are based on taxes" to someone interested in future price behaviour, outside of the direct link between stock price and a sudden wealth effect of a tax reduction?   

While I agree with the theory of initiating an economic system through taxation, and the demand for a currency being based, at least in part, on the tax liability, the system generates more complex behaviour surrounding price determination than taxation alone, I think. 

Edited by Wandering_Dog

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Posted (edited)
9 hours ago, tar said:

You do what? :JC_out_cold:

A bank's assets are based, at its core, on reserve deposits and gov bonds. Hence a bank's loans are based on the idea of someone's future income. That future income is based on the idea that the gov will tax it--tax liability > reserves & gov bonds > private money. 

I can repo a private derivative (a credit default swap) which is based on a mortgage (private loan,private money) which is based on public money (reserves, gov bonds) which is based on future income (gov tax liability) which is based on public money (reserve, gov bonds) in order to re-aquire public money (reserves, gov bonds) to settle a contract which itself is used in repo agreements. 

Everything is that sentence is nothing. It's all just accounting entries. There are no real assets involved. And if the only "real asset" is the tax liability imposed by the gov, is that real? Is it the beating the gov gives out that is real? So our money supply is based on the prisons we will build in the future, but if people always pay their taxes and fees and the punishment is never realized, is it still real?

Edited by Wandering_Dog

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On 1/5/2019 at 5:35 AM, tar said:

After the discussion within the thread "The impossibility of liquidity in xrp" went on I was asked the following:

In the last several hours :crazy: I created a document that hopefully gives a clearer overview of the cross-border settlement process with the use of XRP and the corresponding balance sheet operations as I understood it:

https://de.scribd.com/document/396839492/Xrp-Balance-Sheet-Operations-v1-0

Please do not hesitate to correct me if I have made false assumptions or if you discover any other critical points as I do neither work at Ripple or at any bank that is implementing or using xRapid. The document merely reflects my current gaps in knowledge. :secret:

9th of January, 2019: updated to v1.4

1.001 Millions: Thank You!

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12 hours ago, Pablo said:

in a network of value where counterparty risk is allegedly being "eliminated"

The lawyer in me says you can't eliminate risk, only mitigate or shift it. 

If, on the other hand, the jurists are right and counter-party risk is simply shifted somewhere else, then the unlucky recipients of that risk (who???) 

I wrestled with this for a while. I also say, "risk does not disappear, but it can change forms".

Ultimately concluding that XRPLedger is a "settlement house", which is a word I made up based on what a Clearinghouse's function is in a system of markets like MBSs and SWAPs and the '08 crash. Back then it was ICE who got the job to establish a clearinghouse for the mortgage swaps (insurance) on the MBS portfolios up and running. This is what broke the back of the crash, because all those balance sheets value could be adjusted upward due to insurance against the MBS associated risks.

The function of a Clearinghouse is not unlike the function of insurance, a pooling of risk... specifically counterparty risk. Clearinghouses are sort of like an Exchange, but they typically trade derivative assets, which are usually a zero sum game, so you want to make sure the counterparty to your trade is able to pay up if they lose. The Clearinghouse takes the other side of all the contracts, meaning that the individual traders do not need to maintain knowledge of the default risk probability of every other individual trader.

In the same way that a Clearinghouse changes the form of the conterparty risk, from an individualized risk, to a collective risk. I see XRPLedger changing the settlement risk from a string of individualized correspondent link risks, into a collective counterparty risk.  Additionally by having XRP as a bridge currency, the number of hops, or edges, or links, which a chunk of value must flow through to reach it's destination is minimized, which is good for system efficiency. 

The counterparty of XRP... is the XRPLedger... So what are the risks XRPLedger faces?

13 hours ago, Pablo said:

Transfers of value are no longer solely validated by them and therefore any losses suffered by users of XRP cannot be sheeted back to them alone. I say this because the emerging jurisprudence suggests that miners, validators, nodes and oracles will be a primary target for litigation in the future.

Legally a clearinghouse like the one ICE operates, are fully within the jurisdiction of the US in this case and trades are denominated in USD. So ultimately the Fed's balance sheet is the only CB invoked. However XRPLedger's intended use case is cross boarder, so it must be regulatory compliant in a minimum of 2 jurisdictions, obviously it would be best to be compliant in all jurisdictions. Anyway, Regulatory risks are the primary risk that I see facing XRPLedger, and I believe that the Ripple team has mitigated that risk as best as possible. The ball is not in their court at this point, if Im seeing things right.

In terms of the nature of XRPLedger's counterparty risk... I think you made a good point about who runs the physical machines doing the ledger validation. This seems a kin to "managing the books" and doing all the ledger entries for a co-op or some group project.

The obvious cool thing about DLT is that there is no single person/machine/corp "managing the books". So I view this is as a distribution of that responsibility. However I do believe that one can put in a TX and specify that they do not want their TX validated by that specific validator in Iran, and conversely can specify that they do want their TX validated by this validator they do trust. I say that to ask the question, how much legal responsibility can be assigned to a specific validator, given that the person who is submitting the TX has some choice in the matter. I dont think any of this is ironed out yet.

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17 hours ago, Wandering_Dog said:

"crystallizing imagination"? Jesus, someone please shoot me. :wacko3: No offense intended, these things get me riled up, but if its your thing let's not let it prevent us from enjoying beer :drinks:

Yeah, I didnt like that word when I first ran into it, but with complex systems there is a thing called a phase change. Think of that moment when water crystallizes into ice. Same thing when it turns into steam, both are a phase change, and both require a specific set of environmental conditions.

Here is an academic lecture on "Collective Behavior and Phase Transitions". I have my doubts that Economics as a study will be able to avoid some of this thinking from mapping some physics into econ theory. This same approach is being applied to many sciences, here is a good place to start if you want look at the apporach https://www.santafe.edu/

Here is a 2 part video from Santa Fe Institute with Trent McConaghy (from BigchainDB which I think did some work with Ripple early on)- Tokens and Complex Systems #1  #2

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To simplify things, I would just start with how cross-border transactions are handled currently in balance sheets and leave everything else out of it. Accounting is not as complicated as it here looks to be.

One other point. All related parties handle this transaction different from one another  in their accounting and there is no one way to make it the same for all corporates. 

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Posted (edited)

"Econophysics" started with this guy (coined it)...

https://en.wikipedia.org/wiki/H._Eugene_Stanley

That said, physicists have been poking their big noses into every field (rightfully so) for a long, long time...  In my case, my skepticism of the guy from MIT does not stem from having no exposure to (any particular) field, in fact, it's quite the opposite.  I have a "colitic heuristic" (gut instinct) about not trusting people who collect data to interpret it.

Maybe I'm just old school.  Anyway, carry on!  :)

Edited by NightJanitor

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9 hours ago, Wandering_Dog said:

The central bank can issue reserves without having any assets--in this case, (which I will finish, it's just taking a long time...:focus:), there is no collateral.

Of course, the central bank could also issue obligations without any additional backing (printing press) which would soften the backing of their already existing obligations. Instead of doing that directly, normally the government creates new public obligations that are bought by the central bank (indirectly in normal times, directly in crisis times). If the general trust in the prolongation of public obligations (and therefore the taxes) on the free market diminishes (crisis starts) then the government needs to do this directly sooner or later and then a general inflation sets in (as the backing diminishes). That means that the value of the obligations vanishes. As told: there is no free lunch.

9 hours ago, Wandering_Dog said:

Alternatively, as we have already agreed, you can base the initial gov outlay on the "implied asset" on the Treasury's balance sheet when the gov is created, which is equal to the PV of all future tax income. This tax income isn't required to pay anything, it is an idea that permits the system to maintain accounting consistency when we initiate it. We choose to impose that constraint on the system--you don't have to impose that as a starting condition, the system works the same without it.

The system would not work "the same" as there would be no need to hold or use obligations against the central bank. There is no due date of taxes.

9 hours ago, Wandering_Dog said:

On another note--let's say the US reduces it taxes to 0 tomorrow. Do US citizens stop using the USD? What would be the impact on demand for USD now that the system is already established?

The value of the dollar would extremely decrease (to the necessity to have USD on the remaining due dates of existing private obligations).

The interest rates of US American public obligations would explode and the USA would be bankcrupt.

9 hours ago, Wandering_Dog said:

Similarly, if someone asks me "why are stock prices increasing" and I respond "prices are all based on taxes", are we saying that literally the tax data explains prices with an R^2 of 1? Unlikely. And how helpful is the statement "prices are based on taxes" to someone interested in future price behaviour, outside of the direct link between stock price and a sudden wealth effect of a tax reduction?

I mention it to understand the debitistic system and to prevent absurd theories.

9 hours ago, Wandering_Dog said:

While I agree with the theory of initiating an economic system through taxation, and the demand for a currency being based, at least in part, on the tax liability, the system generates more complex behaviour surrounding price determination than taxation alone, I think. 

The explanation of why you and others accept obligations against the central bank (or cash) and why private obligations against banks are based on them is answered by taxation (and not by the unrealistic, ahistorical regression theorem of von Mises, e.g.). Of course, you can also accept other means of payment. But keep in mind the tax aspects.

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10 hours ago, Wandering_Dog said:

A bank's assets are based, at its core, on reserve deposits and gov bonds.

Not only, see Steuart (1767), «An Inquiry into the Principles of Political Oeconomy. Being an Essay on the Science of Domestic Policy in Free Nations», London: A. Millar & T. Cadell; re-print Düsseldorf: Verlag Wirtschaft und Finanzen, 1993, book IV, part 2, chapter 4, vol. 2, p. 150:

Quote

«A number of men of property join together in a contract of banking. […] For this purpose, they form a stock which may consist indifferently of any species of property [and] is engaged to all the creditors of the company, as a security for the notes they propose to issue. […] So soon as confidence is established with the public, they grant credits, or cash accompts, upon good security; …»

 

10 hours ago, Wandering_Dog said:

Hence a bank's loans are based on the idea of someone's future income.

Assuming, a commercial bank enters a credit contract with no defined additional collateral from the debitor and then the debitor does not pay its obligations... guess, how long it takes before interest on arrears shall be payable and the bailiff knocks on his door :secret:

10 hours ago, Wandering_Dog said:

That future income is based on the idea that the gov will tax it--tax liability > reserves & gov bonds > private money. 

Okay.

10 hours ago, Wandering_Dog said:

I can repo a private derivative (a credit default swap) which is based on a mortgage (private loan,private money) which is based on public money (reserves, gov bonds) which is based on future income (gov tax liability) which is based on public money (reserve, gov bonds) in order to re-aquire public money (reserves, gov bonds) to settle a contract which itself is used in repo agreements.

I do not really understand. Could it be that you are ignoring the different prices (risk factors and interest rates) of all those different property rights, claims and obligations and think they are the same? E.g. the mortgage is based on the valuation of someones real estate. The mortgage itself is nominally fixed, the real estate is not.

10 hours ago, Wandering_Dog said:

if people always pay their taxes and fees and the punishment is never realized, is it still real?

In fact, it is very real, since the mere threat of sanctions is enough for citizens to pay their taxes on time. Why else would they do it? Out of charity to the government?

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Posted (edited)
10 minutes ago, Wandering_Dog said:

I do prefer this narrative, @tar, if we have a distribution problem, what better way to convince people that taxes are a good thing, a necessary thing, than to stick it right at the base of the entire theory? :D

In fact, the distribution problem arises from global tax injustices

EDIT: Or to be more price: This is a more complex issue in terms of innovation potential I have tried to explain somewhere else here :biggrin:

Edited by tar

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