Interest

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Corey

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Jan 28, 2008, 9:32:53 PM1/28/08
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Pardon my ignorance, but I can't seem to grasp the concept of interest. Why is it necessary? Why should Ripple have it at all?

The apex of a design occurs when you can no longer take away any more features - what remains is simply a purposeful, understandable tool. What we need is a decentralized trade system - I don't see why interest is needed in such a system, therefore it shouldn't be present in the design.

I could be wrong, which is why I'm asking all of you. Why do we need interest?

// Corey

Ryan Fugger

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Jan 28, 2008, 11:13:56 PM1/28/08
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Some people feel strongly about charging interest on their accounts.
(I'm sure Daniel Reeves can expound on its benefits for you if you ask
him nicely.)

There are many ways of keeping accounts, and ultimately Ripple will
want to embrace all manner of accounting systems. The simplest design
for a Ripple engine is to leave out the accounting altogether, and
just provide an interface for accounting systems to hook into a Ripple
transaction engine. That's the direction we're going with the core
software, although we'll still probably want to provide simple
accounting systems for individuals who want to do interpersonal
Ripple. When the system is more open to other accounting systems, it
will be easier to justify eliminating interest on Ripplepay, for
example.

Ryan

Corey

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Jan 29, 2008, 3:33:59 AM1/29/08
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If it isn't asking too much, I would thoroughly enjoy a fine schooling by anyone who could tell me how interest is a good thing. But before that, I want that someone to know that I will not buy the thing about interest providing the incentive for people to pay off their debts as quickly as possible because that method of social engineering has clearly failed. Beyond that, I'm all ears :)

Anyway, I asked about the interest thing because interest is an integral part of the debt-based system we're currently using which is failing on an epic scale (or people just really like defaulting). But it seems that exact same system can be easily replicated with Ripple. On the other hand, because of the credit limits imposed on each person, people won't be able to borrow more than they could afford... right? So if I understand it correctly, I would (for example) hold a single total account balance that tells me how well I'm doing overall, much like Billmonk does. Each time I connect with someone new and we set a credit limit with each other, the amount I allow them would essentially be subtracted from my total account balance. Is this correct?

Thank you for your time. I'm sorry for the endless questions but I'm still wrapping my head around the whole concept. I've read everything available already, but there are still issues that linger for me.

// Corey

Daniel Reeves

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Jan 29, 2008, 4:42:07 AM1/29/08
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I agree, interest can be a feature of an accounting system and Ripple,
the back-end system that an accounting system uses for payment
routing, need not know or care about interest. That's the approach
we're now taking. (But since interest accrues continuously it may
still be more convenient to have ripple itself be interest-aware.
Also since it effects the desirability of different payment routes.)

In any case, as Ryan suggests, to the extent that Ripple itself is
being used as an accounting system, interest is an important feature.
You can always set it to zero (or even negative) if you want.

--
http://ai.eecs.umich.edu/people/dreeves - - search://"Daniel Reeves"

Daniel Reeves

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Jan 29, 2008, 5:09:42 AM1/29/08
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I think you're not quite right about credit you extend being
subtracted from your balance. Balances and credit limits are
orthogonal. My (net) balance is the sum of others' obligations to me
and my obligations to others. Credit is only about potential
obligations. Extending you X units of credit means I'm willing to
give you up to X units of stuff (goods, services, anything of value I
can do for you) and expect nothing from you in return but a promise to
repay (ie, obligations from you).

Here's how I've replied when the interest question has come up in the
past, in particular responding to conspiracy theories about how
interest is an enormous scam. There was some google video
circulating a while back that started out very informative and then
spun off into batshit insanity, claiming that it's mathematically
impossible to pay off debts with compound interest, etc..

A thought experiment that has helped me is to pretend there is no
money and just look at movement of wealth. Remember the distinction:
wealth is the actual stuff we want, money is just a way to transfer
it. So the question "how can I repay a loan with interest; where does
the extra money come from?" becomes "how can someone give back more
wealth than they were loaned; where does the extra wealth come from?".
Well that's easy to answer. The same place all wealth comes from:
people make it. They build things, do work, cough up valuable
property.

Say you have a beautiful painting (= wealth) that I want and I have
nothing to offer you for it except the promise to return it to you
later. That's a big favor I'm asking you. To keep things fair, I
might offer you a small thing of my own in return (say, doing your
dishes). So there you have it, I borrowed the painting and paid it
back, plus interest (doing your dishes). Everyone's happy.

It really is, fundamentally, as simple as that.

And, by the way, there's nothing magical or mathematically insidious
about compound interest either. In fact, the concept is already
implicit in this "extra favor" conception of interest. Say our
agreement is that while I have possession of your painting I'll do
your dishes once a week. That's the agreement but now I ask you the
favor of letting me off the hook this week and in exchange I'll carve
you a wooden duck (or something). Work that out with numbers and you
have compound interest. Note that interest only compounds if you shirk
the payments. Compound interest is just simple interest applied
recursively to the missed payments which can be treated as additional
loans.

As for the incentive to pay off debts quickly, it's not really an
issue of social engineering; it arises naturally in a free economy
where each person worries about their own interests (pardon the pun)
and enters into transactions accordingly. That's why if I want you to
give me a house now and I'll return the favor gradually over the next
30 years you'll prefer to sell it to someone who can reciprocate right
now, unless I offer to make it worth your while to be patient.

--

Corey

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Jan 29, 2008, 6:05:08 PM1/29/08
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I think you're not quite right about credit you extend being
subtracted from your balance.  Balances and credit limits are
orthogonal.  My (net) balance is the sum of others' obligations to me
and my obligations to others.  Credit is only about potential
obligations.  Extending you X units of credit means I'm willing to
give you up to X units of stuff (goods, services, anything of value I
can do for you) and expect nothing from you in return but a promise to
repay (ie, obligations from you).

That makes sense, thanks! It appears that I was simply missing an extra variable - the actual balance between two parties. The way I read it on the sourceforge page made it sound like there was only the credit limits. It sounded like this: "When Alice bought an apple from Bob, Alice's credit limit decreased while Bob's increased" - there was simply a movement of numbers. But I think it was just explaining how the routing works, rather than actual transactions that people will see on their end. Or maybe I'm just retarded.

I had some other questions but they're about the interface, so I'll make a separate topic for that.
 
And, by the way, there's nothing magical or mathematically insidious
about compound interest either.  In fact, the concept is already
implicit in this "extra favor" conception of interest.  Say our
agreement is that while I have possession of your painting I'll do
your dishes once a week. That's the agreement but now I ask you the
favor of letting me off the hook this week and in exchange I'll carve
you a wooden duck (or something).  Work that out with numbers and you
have compound interest. Note that interest only compounds if you shirk
the payments.  Compound interest is just simple interest applied
recursively to the missed payments which can be treated as additional
loans.

I've never thought of it that way (as additional loans). Fantastic idea.
 
As for the incentive to pay off debts quickly, it's not really an
issue of social engineering; it arises naturally in a free economy
where each person worries about their own interests (pardon the pun)
and enters into transactions accordingly.  That's why if I want you to
give me a house now and I'll return the favor gradually over the next
30 years you'll prefer to sell it to someone who can reciprocate right
now, unless I offer to make it worth your while to be patient.

Argh, I forgot about that. It's like game theory where players will generally make decisions that provide them with the greatest amount of "win" (I find explaining such things in gamer slang more fun than text book terms, so pardon the expression). eg Money now is better than money later, but it becomes a tougher call when it's some money now or MORE money later.

Thank you for your time, Daniel, I really appreciate it.

// Corey
 

Daniel Reeves

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Jan 29, 2008, 11:01:06 PM1/29/08
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[I pulled out all the stops with the pro-interest arguments below, btw.]

> sourceforge page made it sound like there was only the credit limits. It
> sounded like this: "When Alice bought an apple from Bob, Alice's credit
> limit decreased while Bob's increased"

I can see how that's confusing!
It might be better to define "credit limit" as something fixed and
"currently available credit" as your credit limit plus your balance.
For example, I might have zero credit with you but then you give me an
IOU for $10. I still don't have credit with you but it's as if I do
because I can spend that IOU on stuff from you.
Maybe Ryan actually had in mind to define everything in terms of
ever-changing credit limits where you don't have to think about
balances.
I think that's more confusing though. Suppose I offer you $10 of
credit and you max it out. I would now like to revoke your credit,
meaning "please pay back that $10 and you can't have any future
loans". In the only-credit-limits paradigm there's no way to say
that. You have to wait till the $10 is paid back and only then revoke
the credit.

That's why I feel it's cleaner to treat balances and credit limits as
orthogonal variables.

> Argh, I forgot about that. It's like game theory where players will
> generally make decisions that provide them with the greatest amount of "win"
> (I find explaining such things in gamer slang more fun than text book terms,
> so pardon the expression). eg Money now is better than money later, but it
> becomes a tougher call when it's some money now or MORE money later.

I'm certainly down with the game theoretic interpretation! Let me
also emphasize again the trick of, when something about money (eg,
interest, insurance, crazy financial instruments, etc) is confusing,
to translate into the equivalent in a purely barter economy with no
money at all. That's always possible as a thought experiment since
money is just a tool to facilitate the transfer of wealth. In
practice, of course, our multilateral trades are so complicated that
no one could realistically untangle them (think of all the different
people exchanging their time, labor, expertise, and raw materials for
your whatever-you-do-as-a-day-job when you do something like buy a cup
of coffee).

So, right, getting something now is better than getting something
later. So in a world without interest I'm compelled to forgo the
enjoyment of my own wealth now so that *you* can enjoy it now and I
have to wait till later (even assuming perfect trust, the lack of
which is a secondary reason for interest). Or more realistically, I
just choose to always consume my own wealth or make immediate trades
-- ie, there's no lending. Of course you really don't want to wait 30
years to have generated enough wealth to exchange for a house so we'll
get creative and work out agreements that end up in fact entirely
equivalent to what interest does so elegantly. I understand this is
what happens in Muslim countries where interest is not allowed --
banks use an obfuscated fee structure crafted to be equivalent to
interest. (Unfortunately I have no source for that right now. If
anyone finds one I'd be grateful.)

I may be beating a dead horse now but to attack it from a more
philosophical angle, here's my answer to the question, why *should*
(in a philosophical sense) money "grow"?

Investing money means exactly one thing: deferring your use of it till
later and allowing someone else to use it now. It grows because the person
who gets to use it now compensates you by paying back more than they borrowed
(even if there's zero risk of default or inflation). So why *should* they do
that? In other words, why is it more valuable to spend money now than later?
Because the future is uncertain. If I pick you up from the airport today in
exchange for you picking me up from the airport in 12 years it's clear I got a
raw deal (though if the ride was a gift then that's fine of course). We may
have teleportation by then. Even if you're sure that won't happen or that
nothing else could come up that could get you off the hook for that airport
ride in 12 years, there's always the chance you die tomorrow. So only if we
were immortal could it ever make sense to have literally 0% interest.
And by the way, if you think one favor now for two favors in 12 years sounds
roughly fair, that's what a 6% interest rate corresponds to.

And finally, to convince you that I've really taken these ideas to
extremes, I've even managed to convince much of my extended family to
charge interest on loans to each other (largely because our
ripple-like ledger system does the dirty work of interest calculations
automatically). Here are the arguments I used to persuade them:

1. When you get a 0% loan, it's a favor, for the reasons above, but
it's hard to know how big a favor so the feelings of guilt and
indebtedness might be out of proportion to the favor's magnitude. If
you let Ripple (or whatever your accounting system) add the interest
you can always choose to refund it, making the magnitude of your gift
more explicit.
2. With 0% interest you have to kind of feel each other out to set
the repayment schedule. With a fair interest rate you know you're
fairly compensating the lender for how much additional time you take
to repay. In other words, an interest rate is a simple way to
quantify my urgency for getting paid back or your value for delaying.
By thinking in terms of interest rates we can determine the socially
optimal repayment schedule.
3. The basic fairness issue.
4. More reflective of the true nature of money (money grows).
5. That the ledger does the money-growing automatically so it
doesn't have to feel too business-like.

Here's the rule-of-thumb we use to set fair interest rates:
When Alice lends to Bob, pick a rate right in between what Alice
could get from alternative investments and what Bob could get from
alternative creditors. That way both people benefit equally from the
loan.

I should add that there are plenty of people (and they seem to be
common in the complementary currencies community) feel equally
passionately about 0% interest, or sometimes negative interest
(forgiving debts gradually over time). But all the more reason to
support the feature so that everyone's happy!

Corey

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Jan 30, 2008, 2:52:02 AM1/30/08
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Holy poop, that's a lot of what I needed to know. Mad props, Daniel! Much appreciated.

After messing around with Ripplepay some more, I found its implementation of interest satisfactory - both parties must agree on the rate before it takes affect. (Sorry, I didn't know that before.) Still, the current interface is a bit confusing, but again I'm going to start a new topic for that once I finish checking out some of the other features of Ripplepay.

If anyone cares to help me explore Ripple's feature more, I would appreciate an add. Disclaimer though, I won't fulfill any obligations that take place in Ripple since I am experimenting with it. Anyone else who wants to experiment with it (without worrying about any real obligations to pay or repay or anything) is welcome to add me as a partner as well. Thanks!

And thanks again Daniel!

// Corey

cjen...@googlemail.com

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Jan 31, 2008, 6:53:48 PM1/31/08
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Interest is a messy subject, as is money.

I prefer to distinguish between "Money" and "Money's Worth".

If you have a barter system, like the Swiss WIR, and proprietary
systems like Bartercard, then the minute sellers allow buyers "credit"
or "time to pay", the result is a monetary system, requiring a "Value
Unit" eg Bartercard's "Trade Dollar".

Such "trade credit" is typically "interest-free": but if a seller
charges 8 for payment now, and 10 for payment in 60 days, the
difference of 2 is "interest".

The trouble is that we have a system where Banks act as "credit
intermediaries" coming between buyer and seller and providing the
necessary credit or "time to pay" by issuing IOU's which circulate as
"money".

The "interest" banks charge in respect of the loans that create this
"debt money" has three components: operating costs; default costs,
and profit.

What banks do, essentially, is to guarantee the credit of the buyer
and back their guarantee with an amount of regulatory capital set by
the Bank of International Settlements in Basel.

So: for the unsecured credit that makes the great "Wheel of Commerce "
go around, the "interest" charged by banks is essentially their
operating costs, plus the cost of the guarantee they provide - and as
much profit as they can gouge within a credit creation monopoly.

Secured credit is another issue.

Here we are entering into "Investment". The return generated by a
productive asset, such as a house (ie the "property rental value), is
split between the owner and the investor.

The trouble is that the "investor" using a "secured loan" or mortgage
loan is getting a fixed return which has nothing whatever to do with
the actual return generated by the asset.

Here, the "interest" is a "return on capital" and the return is
normally related to:

(a) the supply and demand for "capital";

(b) the perceived "risk/reward" ratio.

So an investor in a risky project like a film may be looking for a
100% return, while an investor in 50 year index-linked secured debt
issued by a water company may accept a return of 1.49%.

Credit has a cost - and that may be characterised as "interest" -
consisting of operating and default costs (plus profits)

Capital has a cost - which is the market price - and again could be
characterised as "interest"

But neither of these costs has anything whatever to do with the
arbitrary rates of interest set by Central Banks: because Money per se
has no "cost" except in a system where Money is issued as Debt/Credit,

Btw: "compound interest" insofar as it relates to money issued by
banks is entirely different in character to the example given to you
in the thread, where a seller provided value to the buyer, who then
deferred settlement by asking for increased "time to pay".

Personally I would prefer to see "money's worth" - such as units of
energy or land rentals - circulating within a clearing network/union
with "time to pay" = credit supported by a mutual guarantee, itself
backed by provisions made into a default pool or fund.

Best Regards

Chris Cook
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