Debt is weird. You borrow something against some collateral you have and return that something, usually with interest later on. Technically speaking, debt is a displacement of money over time, allowing you to bring consumption forward. What's weird about it isn't the mechanism, but what happens with the collateral.
The collateral is something you own and by putting that up against what you're borrowing, it's not really "owned" by you anymore, but rather shared. There's a debt contract where you own the collateral if you pay back what you owe, or the lender owns the collateral if you don't. It's like Schrodinger's cat, but with property. The ownership of the collateral doesn't resolve until the debt is settled through repayment or default. And since the debt settlement is in the future, the property rights around the collateral are in an in-between, uncertain state in the present.
Now I'm not writing about possession or property rights in the legal sense. Various jurisdictions have different rules about who controls the collateral during the time of the debt. For mortgages, the borrower gets use out of the house, for pawning, the store takes possession during the duration of the loan. That's a practical question and the rules differ. When I say that debt is weird, I'm talking more about the metaphysical property right. Whose is the collateral?
It's a bit of a tangled web because both parties have some claim to it. It's not entirely owned by one party or the other during the duration of the loan, and it's that ambiguity that debases the collateral in question. Suppose, for instance, that during the duration of the loan, the collateral is exploited in some way as to reduce its value so that it no longer covers the cost of the loan. This very well may be the economically rational thing to do if the borrower plans to default.
Take for example an auto loan. The borrower can use the car as an Uber during the months it takes for the bank to repossess it to earn money while depreciating the value of the car. Similarly, a person with an underwater mortgage may use the place to host events and trash the place while not making payments.
In other words, the lack of clarity around who owns what makes for bad incentives. Of course, this is exacerbated in a fiat monetary system as debt, particularly collateralized debt, is ubiquitous. The debt printed out of nothing decreases the incentives to take care of property that ends up as collateral.
In other words, debt, especially fiat debt, debases the things society finds most valuable, particularly as the debt goes bad and default becomes imminent. Of course, there are many debts that are repaid and collateral remains pristine. But those are situations where the loan plays out as expected, that is, the collateral stays at or increases in value. When the unexpected disasters happen, particularly when it's at the macro-economic level, the mechanism of fiat debt ends up destroying way more value than simple possession.
Which brings us to the many different debt mechanisms in the Bitcoin space. The more I study it, the more I'm convinced that adding debt mechanisms is generally not a good idea. I think it's fine for two consenting parties to do a debt contract. But complicated "DeFi" solutions all end up in weird places because of the lack of possession. There usually ends up with some trusted party that abuses the collateral in their possession and we get disasters like 3AC, FTX, DCG and Celsius.
As Hoppe says, all rights are property rights. Let's not debase it in some degenerates' quest to play more financial games.
Feel free to repeat and bold this line:
There usually ends up with some trusted party that abuses the collateral in their possession.
It happens so often, and it can ruin peoples lives. It is also at the core of so many financial problems that people, or countries, run into.
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"during the duration" might be your literary "curiouser and curiouser". I like your Schrodingers cat comparison, it illustrates the magic trick of it well. I'm interested in how this works with shared multisigs where the "ownership" of the funds are split/duplicated in a similar way.
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It's an interesting post but I'm not seeing the ways that BTC, as collateral, can be 'debased', as you put it. (I would have used the word 'degraded' instead, as 'debased' has a particular meaning with respect to currency.)
You give examples of cars and houses being misused while in the possession of one party as collateral but we are often told that Bitcoin is the 'perfect collateral', and one way that Bitcoin is perfect as collateral is that it is entirely virtual in nature, and thus can't undergo any physical abuse or sustain physical damage.
The only way that I can think of that a certain quantity of Bitcoin can become damaged is if it is split up across a greater number of UTXOs, perhaps to the point where some of the Bitcoin becomes 'dust' at a later point in time. We have seen quantities of Bitcoin become dust over the last ~15 years but I don't see why this dustmaking would be done by either party, or even a third party, when Bitcoin is used as collateral.
Certainly we should be very careful as to how possession is treated of any Bitcoin we use as collateral. And be very wary of rehypothecation but, again, Bitcoin has properties that can prevent that (a transparent blockchain). But I'm still not seeing how the actual Bitcoin gets degraded while being used as collateral, versus something like a valuable painting that may be incorrectly stored or damaged or vandalised while held as collateral. You may lose it, as is the risk of all collateral, but if you get it back it should be just as good bitcoin as when you loaned it out (except, perhaps, no longer as privately held).
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