Clearing up Crypto Credit

Darren Zal
7 min readJul 14, 2021


A fair in Champagne in the 13th century

You often hear that money was invented to replace the barter system of “I’ll trade you this for that,” however, anthropologist David Graeber found credit was the first form of money as a formalization of “I”ll owe you one” and metal coins came later as a means for kingdoms to pay soldiers and collect taxes.

Metal coins were common in late Medieval Europe, when merchants travelled from city to city trading goods at market fairs, however, paper credit instruments like bills of exchange emerged as a convenient form of cashless payment among merchants. A decentralized multilateral clearing process emerged to settle such debts. Credit financing combined with this liquidity saving mechanism reduced the need for merchants to carry gold coins along dangerous trade routes.

The clearing process involved three steps:

Step 1: Bilateral clearing
In the example below, both debts would be cancelled.

Fig 1. A owes B, B owes A

Step 2: Cycle clearing
In the example below, all debts would be cancelled.

Fig 2. A owes B, B owes C, C owes A

Step 3: Chain clearing
In the example below, A would owe 1 unit to C after clearing.

Fig 3. A owes B, B owes C

At settlement events after trade fairs, merchants would gather to clear their mutual debts, agreeing to remove cycles and shorten chains. Through this process, merchants were reduced to their net position, which could be settled in coins or by drawing up a new bill of exchange.

Three interesting properties of clearing:

  • Bilateral and and cycle clearing eliminate the need for cash.
  • The order of clearing deosn’t change the net position of any participant but the order of clearing can change the creditor-debtor relationships, ex Fig 3. This added to the social dynamics of clearing at fairs due to perceived creditworthiness of each merchant.
  • Time is an important factor because time allows additional transactions to grow chains of debt. Ex, in Fig 3, if B buys from C on credit, then time allows for B to sell something to A for credit, which cancels B’s debt

Informal trade credit clearing spread in Europe from the 13-18th centuries.
In the 17th and 18th centuries, bankers and stock traders adopted the practice to settle their own debts and eventually developed more formal and centralized clearing institutions, such as the London Clearing Club in 1775 for settling bank debt. The benefits of liquidity savings caused clearing houses to spread globally. In the US, clearing institutions such as the NSCC and the DTCC were born. Today, the DTCC clears $2.15 quadrillion in securities every year.

..on a typical trading day, NSCC processes an average of about $1.7 trillion in equities transactions. The multilateral netting process reduces that number by about 98%, and the total value settled is around $38 billion. [3]

An interesting example of clearing is found in the country of Slovenia. Since 1992, businesses have been able to submit invoices to a government agency which multilaterally clears them every month. Even with relatively low participation rates (1–8% of businesses), this saves businesses 0.5–2% of GDP on average and up to 7% in times of crisis such as the aftermath of 2008.

A large part of Slovenia’s GDP is from international trade, which limits potential liquidity savings from the internal system. What would the benefits be if all trade was included? A study was done on historical data from Sardex, a B2B local currency system in Sardinia. The results showed monthly clearing yielding 25% liquidity savings. In addition, when businesses were given a source of internal liquidity at a rate of 2% of turnover (mutual credit up to 2% of sales volume), another 25% of debts were cleared. Together, multilateral clearing and mutual credit reduced the need for cash by 50%.

All cycles in Sardex transaction from May 2019. Sample cycles highlighted.

Remember that in trade fairs, merchants were sometimes allowed to draw up new debt if they ended with a negative position after clearing. This is similar to the way mutual credit worked in the Sardex study. If clearing resulted in a negative position for a business, they could roll over their balance (up to 2% of their turnover). The study shows that a modest source of internal liquidity is just as beneficial as multilateral clearing, and together, their benefits are additive. A question for future research: For a given economy using periodic multilateral debt clearing, how much internal liquidity (ie mutual credit) would it take to completely eliminate the need for cash?

Since Medieval times, trade finance has centralized into large banks and clearing houses. Wealth and power have concentrated in these institutions which charge interest and control who has access to credit. However, distributed ledger technologies (DLT) such as blockchain are moving finance in the decentralized direction, with the potential to dis-intermediate financial parasites, leaving more wealth in the hands of those who provide valuable goods and services to society.

The first implementation of DLT was Bitcoin (BTC), a decentralized digital commodity akin to digital gold. Like gold, Bitcoin is volatile and scarce and not an ideal spending currency. Unlike Gold and Bitcoin, credit can be denominated in a stable unit of account and be created and destroyed to harmonize with the expansions and contractions of the economy.

Similar to how credit backed by gold naturally emerged in Medieval times, credit backed by BTC emerged with the Lightning Network (LN), which allows BTC users to make credit payments across a layer 2 graph of payment channels with settlement on the layer 1 Bitcoin network.

The Lightning Network sits on top of the Bitcoin blockchain

The lightning network is interesting as a decentralized credit graph but requires pre-funding and settlement in BTC. Just as most credit is no longer backed by gold, we are seeing crypto credit abstract away from BTC to be backed by various collateral and trust. In Kenya, small businesses are minting community credit by promising to redeem it for their own goods or services. Trustlines is building a decentralized mutual credit network. A growing list of projects such as MakerDAO allow anyone to deposit tokenized collateral to withdraw credit as a loan denominated in fiat.

Crypto credit could be very useful for supply chains (value networks), which naturally form chains of trade credit which could be cleared multilaterally. Similar to how the LN allows BTC-credit to ripple through payment channels, a blockchain could allow trade credit to ripple through a network of businesses’ general ledgers. Such a system of decentralized clearing of trade debt could save businesses 95% of the $3.9 trillion of working capital locked up in global supply chains.

DLT allows communities to issue and govern their own credit currencies rather than depend on external liquidity which can dry up even when people have goods and services to trade. A diversity of local currencies allows for innovation, adaptation, responsiveness, and resilience in economies in the way a diversity of species allows for a healthy ecology. Interoperability of DLT allows for linking local currencies at higher scales (for example with liquidity pools) to enable global trade. Composability and computing capability of DLT allows for lower level primitives to connect together like Legos to create a higher level ecosystem of decentralized finance (DeFi).

Today, our money system has an unsustainable growth imperative and our accounting externalizes non-financial value. Non-interest bearing local currencies can be designed for qualitative growth rather than quantitative growth and the underlying DLT can also account for material flows (ie REA accounting) to internalize multiple forms of capital. Transparency, governance, automated execution of rules and other features afforded by blockchains can help in funding public goods and commoning.

With our economic systems pushing ecosystems towards collapse, we need a transformative shift in our collective management of resources. We must provide a foundation of resources for everyone while respecting outer environmental limits. We can learn to live in this sweet spot by applying to economics the principles of living systems, such as robust circulatory flow. Circulation of economic resources mitigates extraction and waste and as we have seen with cycles of credit, no cash is needed to finance the flow.

Blockchains can evolve beyond digital gold and provide the substrate for a permaculture of credit currencies, material accounting, public goods funding, commoning, and other vital economic systems which can link together in open value networks. Blockchains are a valuable new strain of mycorrhizal technology, like the internet and neural networks, that we can use to collectively manage our interconnected world.



Darren Zal

Writing in service to life.

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