3.3 Distributed risk management

In traditional finance, the role assigned to banks is that of a “prudent lender,” at least theoretically speaking. While leveraging the aggregated capital of the public to issue loans, the required level of prudence is achieved because uncollectible accounts automatically convert into liabilities on a bank’s balance sheet. Endless complexities of modern risk-repackaging schemes aside, exposure to this threat is what is supposed to balance banks’ profit-motivated tendencies to be less-than-prudent creditors.

In traditional mutual credit scenarios however, neither the profit motive nor the peril of being held accountable for bad debt exercise material pressures on the behaviour of mutual credit system operators. Rather, a morally based commitment to the health of the community is what drives the decisions of the ecosystem’s administrator. Failure to manage these systems vigorously can, and often does, result in a runaway accumulation of unpaid debt, and hence a dramatic excess in circulating currency units, which ultimately leads to their collapse.

The goal of ReSource is to reintroduce the economic incentives driving for-profit financial institutions to assess creditworthiness, extend credit prudently, and assume the required levels of risk, while distributing these functions among participants of a mutual credit network, rather than centralizing them under the roof of one profit-motivated entity, such as a bank—or a blockchain startup, for that matter.

Since the ReSource Protocol lends itself to different levels of distribution and decentralization, protocol mechanics support different levels of distributed risk management. In a fully decentralized scenario, the roles of verifying credit scores, underwriting loans, and assuming risk fall on willing members of the network itself. Naturally, these services are rendered voluntarily in return for a share of network proceeds, and they are supported by a series of automated processes to reduce human error.

In intermediate stages of decentralization, underwriting roles may fall to specialized entities partaking in the network. However, the Protocol mechanics to facilitate the former and latter stages are the same. This is comparable to the Bitcoin protocol as a “peer-to-peer electronic cash system,” which was designed to operate in an environment in which most address holders serve as miners, but which has attracted specialized mining farms in its mature state.

Consequently, risk assumption is a role within the ReSource Protocol that can be occupied by anyone willing and able to do so, much as mining is a role within the Bitcoin and Ethereum protocols. As will be explained hereafter, the process of risk assessment and underwriting will be assisted by the Protocol’s underwriting algorithm. The actual assumption of risk, meanwhile, falls on network participants, who will be able to take on this risk via various SOURCE staking mechanisms and pools. (SOURCE is the network’s governance token, used to underwrite credit lines and pay network fees. Its token economics will be elaborated on in the chapters that follow.)