Trust-based Currencies on Blockchain: Trustlines Network, Circles UBI, and Karma

When we talk about money, most people think of its physical form, that is, banknotes and coins. Of course, nowadays we rarely pay with physical money. Most of the time, we use a bank card, which is much more convenient. One might think that the money on the bank card is the same as the money we can hold in our hands. Many believe that the bank card is just a convenience and that the money on it rests in a bank vault. However, this is a huge misconception!

When we look at our bank account and see that there is $1000 in it, it doesn't mean that this money exists anywhere in physical form. It simply means that the bank owes us $1000. The bank guarantees that we can withdraw this money in physical form from an ATM at any time, but this rarely happens because using a bank card is more convenient. It's like the "IOU notes" in Dumb and Dumber.

The money in our bank account is essentially the bank’s debt to us, and this debt serves as the medium of exchange. If we pay with a bank card and the seller also uses the same bank (so there is no interbank transfer), the bank simply adjusts the debt on its books. If we pay $100 at a store, the bank now owes us only $900, while it owes the store owner $100. As long as we don’t withdraw the money from an ATM or there’s no interbank transaction, the bank only needs to reallocate the debt back and forth.

Let’s look at a simple example. We take out a $100 loan from the bank. The bank then credits $100 to our account. We can spend this money with our bank card just like we would with cash, so the bank has effectively created money out of thin air. We spend this $100 at a store and buy something. For simplicity’s sake, let’s assume the store owner also uses the same bank as we do, so the transaction is completed through a simple ledger adjustment. Later, we repay the $100 debt to the bank, which then eliminates the loan.

But what exactly happens? Since the money in the account is the bank’s debt, what actually happens is that when we take out a $100 loan, we incur a debt to the bank, and the $100 that appears in our loan account represents the bank’s debt to us. When we pay with this money at the store, we are essentially transferring this debt. After the payment, the bank owes the store owner. So, we owe the bank $100, and the bank owes $100 to the store owner. This raises the question: why do we even need the bank? Why do I need to take out a loan from the bank and pay interest on it? Why can’t I just buy on credit from the store and pay the store owner later?

The answer is very simple: it’s because the bank is a very reliable debtor, while we are not! But if that’s the case, why does the bank lend us money? Why is it that the store owner doesn’t trust us enough to give us credit, but the bank does?

When we take out a loan from the bank, the bank assesses how risky it is to lend us money. The bank evaluates our assets, our regular income, etc. If we happen to be unable to repay the debt, the bank has legal means to recover the loan. For example, they can auction off our car to settle the debt.

The bank is, therefore, an intermediary that converts unreliable debt into reliable debt.

The entire modern monetary system is built on trust. In fact, since banks create money out of thin air, money is nothing more than embodied trust! For those interested in the deeper history of money, you can read my previous article, which explains how money transitioned from decentralized trust to centralized trust.

Obviously, no one likes to lend money to strangers, which is why we need a reliable intermediary: the bank. But what happens if there is sufficient trust between the seller and the buyer? We are happy to lend even hundreds of dollars to a friend or family member because we know they will pay it back. In a friendly transaction, there is no need for a bank.

And what about a friend's friend? We don’t know them directly, but in the case of a $100 purchase, we could lend $100 to our friend, whom we trust, and they could then lend that $100 to their friend, whom they trust. We can call this a kind of "transitive trust." Thanks to this "transitive trust," even longer lending chains can be created where there is no need for a bank. According to the “Six Degrees of Separation”, on average, everyone on Earth knows each other through six people, which means that relatively short lending chains could cover the entire world, eliminating the need for a bank as an intermediary.

The accounting for these chains would be quite complicated if done manually, but fortunately, with modern technology, it can be easily managed. However, it's crucial to have a global accounting system that cannot be tampered with and that everyone can trust. Luckily, we have such a system: the blockchain.

"Transitive trust" is the foundation of the Trustlines Network project, which implements exactly the concept described above on the Ethereum blockchain.

The foundation of the Trustlines Network is the credit line, which is the line of credit between two acquaintances. In the above example, Alice and Bob have both set a $10 limit. If Alice wants to buy some apples from Bob, she pays him $5, which, like a bank account, is simply an entry in the ledger. Alice gets the apples, and a $5 debt appears on the blockchain toward Bob. If later Bob asks Alice to cut his hair and pays her $10, Alice's debt disappears, and now Bob owes Alice $5. Two financial transactions were successfully completed, and there was no need to involve a bank.

When a third person, who doesn’t know Alice, enters the picture, “transitive trust” comes into play. If Alice wants to buy a kilogram of pears from Charlie for $5, she can’t do it directly because Charlie doesn’t know Alice. However, Charlie knows Bob, so the transaction can be completed through Bob using a multi-hop payment. Charlie gives the pears to Alice, and on the blockchain, it is recorded that Alice owes Bob $5, and Bob owes the same amount to Charlie. As you can see, the system works perfectly well between strangers through the network of relationships, without the need for the bank as an intermediary. All that’s needed is to find a path between the two parties.

Circles UBI implements a similar logic, and it is not just a monetary system but also a Universal Basic Income (UBI) implementation.

The essence of Universal Basic Income (UBI) is that every person should receive a regular monthly allowance by default. The idea of "free money" may seem strange at first, but it can be justified in many ways. The social and ethical arguments are clear: every person has the right to a life of dignity. However, there are also economic reasons. For example, if people are not in a desperate situation because they don’t have to work just to survive, competition in the labor market increases, leading to fairer wages. Therefore, UBI can stimulate competition, which is the foundation of the modern capitalist economy.

When we talk about basic income, the first question is always where we will find the funding for it. According to the classic theory, the state must collect the money in the form of taxes, which is then distributed as basic income. This seems logical enough, but there are other theories that suggest this may not be strictly necessary.

According to Modern Monetary Theory (MMT), for example, the state can freely print money to cover expenditures important to society, such as unconditional basic income. Advocates of classical theory respond that printing money generates inflation, but MMT argues that this is not necessarily true. Inflation occurs when there is more money in the economy than there are resources. In such a case, more money is allocated to each unit of resource, which devalues the currency. However, the amount of resources fluctuates, so if the state controls the supply of money properly, it won’t lead to hyperinflation. To maintain balance, MMT also considers it important to collect taxes, but while classical theory holds that taxes are necessary to cover expenditures, MMT believes taxes are needed to regulate the money supply. According to MMT, the state doesn’t collect taxes to fund its spending (this is done through money printing), but to “burn” the collected money and thus regulate the amount of money in circulation, controlling inflation in the process. If the state funds basic income through freely printed money, it is called monetary basic income.

Circles UBI is essentially an implementation of such a monetary basic income on the blockchain. The key idea is that instead of a single currency issued centrally by a state, each member has their own currency. So, instead of a uniform dollar, there is Alice Dollar, Bob Dollar, and so on. It’s as if every person had their own country with their own central bank, issuing their own currency. This currency is distributed to the individual as basic income, which is guaranteed by a smart contract. For example, Alice receives 10 AliceCoins every day as basic income, which she can use to manage her finances. This method of currency creation establishes the scarcity of AliceCoin, which is necessary for it to function as money.

Just like in the Trustlines Network, trust determines whose money is accepted by whom. If Bob trusts Alice, he will accept AliceCoin as payment. If Alice trusts Carol, she will accept CarolCoin as payment. The relationships are transitive, just like in the Trustlines Network. So, if Carol wants to pay Bob, she first needs to exchange her CarolCoin for AliceCoin. The exchange between trusted parties always happens on a 1:1 basis.

To ensure that late joiners to the network are not disadvantaged, the money continuously inflates, so the advantage of early joiners quickly disappears compared to those who join later. Inflation also acts as a form of redistribution, smoothing out differences between members. It can be seen as a kind of wealth tax, as those with more are affected more. For example, if money loses 10% of its value each year, someone with $1000 loses $100, while someone with $100 only loses $10. Since everyone receives basic income equally, this mechanism helps to reduce inequalities. The downside of this solution is that it may be difficult for people to track inflation. For instance, the price of a crate of apples will constantly change due to the built-in inflation. To avoid this, it’s advisable for the user interface to display not the actual amounts, but the inflation-adjusted values. This way, if no other factors (such as changes in demand or supply) affect the price of apples, it will appear fixed on the UI.

Due to the UBI logic, the operation of Circles UBI's currency is similar to Bitcoin, where a certain amount of coins is distributed every 10 minutes. However, while in Bitcoin the miners compete for the coins, in Circles UBI the members receive them by default which is more fair.

The great advantage of such "transitive trust" systems is that they are protected against Sybil attacks or fake accounts. Imagine someone generates 1000 accounts and collects the regular basic income from each. Such an attack could easily ruin the entire system. However, since the money can only move along paths designated by personal trust, fake accounts are not a problem because no one will trust them. For example, if Alice creates a fake account, it won’t be of much use to her, as only Alice would accept the FakeCoin from the fake account.

At the same time, these systems have significant drawbacks. They can only function well if the network is dense enough. If Alice knows Bob, and Carol knows Tom, Alice can trade with Bob, but she cannot trade with Carol or Tom because they don’t have a mutual acquaintance. This problem is solved by Karma, which is my own network money concept.

Karma uses the "proof of unique human" concept instead of the "web of trust." The essence of this is that if we can ensure, through a third-party solution, that each person can only have one account and that fake accounts cannot be created, direct trading becomes possible. Several such third-party solutions exist. One example is World's WorldID, which ensures uniqueness based on retinal scans, or Proof of Humanity, which is a complex web of trust-based solution. Any KYC (Know Your Customer) solution that guarantees uniqueness can also serve this purpose.

The core philosophy of Karma is that personal trust is not necessary. All that’s needed is a large public ledger where everyone’s debts are visible. Each person’s reputation depends on their debt, so it is in everyone’s best interest to reduce their debt in the long term. Those with large debts will find that others are less willing to trade with them.

Karma implements all of this in the form of a simple ERC20 token, where each person’s balance starts at 0 and increases with each payment (the balance here represents debt). Each person can only have one Karma wallet, ensured by WorldID or Proof of Unique Human registration. Since it is a simple ERC20 token, payments can be made through any standard interface.

If Alice buys a crate of apples from Bob for $10, Alice incurs a $10 debt to Bob. If Bob then buys pears from Carol for $10, Bob incurs a $10 debt to Carol. Finally, if Carol gets her hair cut by Alice for $10, she also incurs a $10 debt. So, everyone has an equal $10 debt, which is publicly visible. These circular debts need to be resolved in the system to update the members' reputations. This is not a trivial task, similar to finding a route on a map. That’s why there are "miners" in the system who search for and resolve such circular debts. When a miner finds such a circle, they submit it to the system, which resolves the circular debt, reducing all members' public debt to $0. Since it is in the members' interest to improve their reputations, they pay a small transaction fee to the miner.

Although I used dollars in the example, I envisioned Karma primarily as a favor-based currency, where 100 karma would represent one hour of work. This could foster a favor-based economy. For example, Bob mows Alice's lawn, and Alice pays him 100 karma out of gratitude. Then, Alice cuts John’s hair, and John also pays her 100 karma. Finally, John gives Bob a ride when he is hitchhiking by the road, and Bob thanks him with 100 karma. Instead of financial transactions, these are “favor transactions,” so the philosophy is similar to that of karma, which says that if we do good for others, good things will happen to us as well. This system thus quantifies karma. In this context, karma can be seen as a kind of gamification of providing favors, where members compete to be the better person.

Karma was originally created as “favor money,” but as the example above shows, it works well as a complement to or even a replacement for the traditional monetary system. It’s like a P2P lending system where the collateral is the unique identity of the individual, which is a strong form of security. If someone fails to settle their debt, they will never be able to receive credit from anyone in the world again, effectively being excluded from the system forever—this serves as a powerful deterrent.

The biggest limitation of the trust-based systems described above is personal trust itself. High-value transactions (worth thousands of dollars) cannot necessarily be handled solely through personal trust. In the case of banks, this is possible because they are backed by the law. If we take out a $100 loan, our entire personal wealth serves as collateral since the bank can auction off our car if necessary to settle the loan. Blockchain-based currencies cannot offer such guarantees. However, what we can do is tie assets to a smart contract, which can serve as collateral in the event we don’t settle our debts, thereby building additional trust. For example, on the Gnosis chain, we can easily deposit 1000 xDAI, which is equivalent to $1000. If we fail to settle our debt to someone within a certain period, the collateral can be claimed on this smart contract in exchange for xDAI. This solution provides a strong enough guarantee even for high-value transactions.

Let’s look at an example of how all this would work in the case of Karma. Bob is a programmer who works for a DAO-operated Uber-like company. The company connects drivers and passengers and charges a transaction fee, which it uses to sustain itself, develop the software, etc. Bob fixes a bug for the company, for which he receives $100 worth of Karma. Bob can rest easy because the company has locked a portion of its governance tokens in a smart contract as collateral. If Bob doesn’t spend the $100 worth of Karma within 3 months, he can exchange it for the governance tokens used as collateral and sell them on the market. The best-case scenario, of course, is that Bob spends the Karma. For example, he asks Alice to translate a legal document for him. Alice asks for $100 worth of Karma in return. Since Alice frequently uses taxis, the $100 Karma would go back to the DAO as a transaction fee. This closes the loop, and the governance tokens remain in the collateral pool.

Asset collateral can, of course, work in the case of Trustlines Network and Circles UBI as well, helping to establish connections between members who don’t have personal trust. This, in turn, can solve the problem of sparse networks.

It is clear that the trust-based currencies mentioned above can be ideal complements to the existing monetary system, or in some cases (e.g., local communities with local economies) even replace it. The real takeaway is that the term “trust-based currency” is actually meaningless, as all forms of currency are trust-based. The only difference between currencies is who we need to trust—the state, banks, smart contracts and assets, or each other. It's important to understand that the blockchain-based currencies presented above are not “play money.” They are just as legitimate as the money we see in our bank accounts.