Jason C.


What Does an Equity-Based Economy Look Like? 2018-01-11

Cryptocurrency, bitcoin in particular, has the power to revolutionize the world.

We currently have a debt-based economy. That means that many financial transactions are done on credit. People rarely buy a home or a car outright, they usually take out a loan.

I'm not a financial expert, so I'll tread lightly on explaining how the system works. But basically banks loan out money they don't have, they've been doing this for centuries, it's called fractional reserve banking. This is essentially how new money is created and it works as long as everyone trusts the banks and don't all try to withdraw their money at once - which is what started the great depression btw. (For more info about fractional reserve banking, see additional resources at the end of the article.)

The 20th century has seen an explosion in debt and many say credit has been driving the prosperity in the world. Instead of saving your whole life to start a business, you can go to the bank and apply for a loan. Just imagine how long it would take to save for a house if we didn't have mortgages.

Sounds great, doesn't it?

Well, it may seem great, but it's definitely not perfect. Economics is more art than science, so I'm not going to claim the future crypto world is a silver bullet. But I will point out a few properties of the current system and explore how crypto could change things.

The Current Debt-Based Economy

First, the enormous debt in the world (currently in the $100's of trillions) generates a lot of interest. Just look at a mortgage - in the lifetime of the loan, interest can account for sometimes as high as 50% of what you paid. Where exactly is all this interest going?

Well to the banks of course. While you're working hard trying to pay off your home, the bank is raking in huge profits. And thanks to fractional reserve banking, they didn't even have to actually have the money for the loan.

Second, all this new money generation doesn't come for free. Enough new money is generated via debt each year that the value of each individual dollar is reduced. It's called inflation and many think it's a good thing.

Without inflation, people are not incentivized to invest or to spend money. As the value of your money goes down over time, you are better off investing it. Similarly, you are better off spending money earlier as prices will likely go up over time. This helps drive the economy.

Purchasing a Home Without a Loan

Okay, now what's an equity based economy and how would it work?

So homes are expensive, how could you buy a home without taking out a loan? Well imagine a home was like a public company that issued shares. Instead of purchasing the entire home at once, you could buy a few shares in the home (e.g. 1% of the home).

Alright, this is weird, am I allowed to live in a home that I own 1% of? Well, not exactly. You have to separate the concept of ownership and rent. Owning 1% of a home means you're entitled to 1% of the rent, kind of like a dividend. Each month the tenant would pay rent and it would be distributed to the owners. If you owned 100% of the home you would be entitled to 100% of the rent, so you could live there for free.

So is this better than the current system? Well, first of all there's no bank or loan required. No interest being syphoned off unnecessarily.

And another great thing is, if you're slowly buying the place you're living in, your rent will actually go down over time. For instance, if you've purchased 25% of the home, then you're entitled to 25% of the rent, which basically means your rent would be 25% off.

There are lots of other effects this would have, but hopefully that covers things at a high level. At least enough for you to consider there could be better systems than our current one :) Someone is already starting this by putting their house on the blockchain, check out the link in the resources section.

Is Deflation Bad?

Now how about this world without inflation, what does that look like? And wouldn't everyone just save money forever and never spend any of it or invest in anything?

First lets explore what deflation looks like. Lets imagine a world where there is only 5 bitcoin and 5 houses. In this simple world a house would be worth 1 bitcoin. Now lets say someone comes in and builds 5 more houses. Now with 10 houses, each one only costs 0.5 bitcoin each (5 bitcoin divided by 10 houses).

If you had 1 bitcoin and had bought one of the original houses, you could now only sell it for 0.5 bitcoin and would've lost money. If you had kept your 1 bitcoin and waited until the 5 additional houses were built, you could now buy 2 houses. So why would anyone have bought one of the original 5 houses?

The answer is, they wouldn't have - but that's not a bad thing. What's happened here is that housing supply was not meeting demand, so purchasing one wasn't a good idea. But that doesn't mean holding onto your bitcoin was a good idea either.

The real winner is the person who built the 5 new houses. Even though the price of houses dropped to 0.5, as long as building cost you less than 0.5 bitcoin, you've actually made a profit compared to holding onto your original 1 bitcoin.

Even if you already owned your home and didn't have to worry about rent, if houses are in high demand you are incentivized to build more rather than hold onto your money.

So even with deflation, normal economics still play out. Just because you can safely save money doesn't mean people will stop investing. As long as people want more than they have, they'll need to work to generate additional spending power.

Conclusion

With cryptocurrency you don't need debt to have a functional economy. Using smart contracts and tokenized assets a whole new world of financial technology is possible. Inefficient middlemen can be removed making assets more fairly valued. Better supply and demand feedback will create a more efficient market, benefiting everyone.

Changing the way the world financial system works is pretty scary. It's not something the whole world needs to switch to overnight though. Just like how superior democratic countries slowly outpaced legacy monarchies, people in the world are starting to try out equity based economies. They will compete with the existing approach and if it's a better system it will gain acceptance.

More Resources


← Back to all blog posts