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Background FAQ

Some questions we think might get frequently asked.

What is this all about?

From a bird's eye perspective, the Frankencoin system resembles a bank that creates money against collateral. In the traditional banking system, this can for example be done with real estate. The bank accepts a house as collateral, and prints the agreed amount of money by adding it to that persons bank account. Then the buyer of the house can transfer the money to the seller, where it ends up as a deposit with maybe the same or another bank, thereby closing the circle. When doing so, banks need to observe some reserve and other legal requirements to ensure the mortgage is well-secured. The Frankencoin system essentially enables users to do the same, printing some money against a (hopefully) valuable collateral. Also, like a bank, the Frankencoin system has a reserve pool that resembles the equity capital of a bank and serves as a buffer to absorb risks. However, in contrast to a bank, there is nothing that qualifies as credit as the users print their money themselves, processes are largely automated and fully transparent, and there is no explicit governance besides a veto mechanism that is open for everyone with enough pool shares.

Is this useful?

If used with the necessary care, most definitely. Most of the usefulness of the Frankencoin comes from its decentralized nature. It is open, fully transparent, and freely interactible by humans and software alike. Thanks to its transparency, anyone can analyze its solvency at any moment. If it is in imbalance, it can be expected to be attacked by speculators who know exactly at which market prices the Frankencoin is not fully backed any more. The goal is not to imitate traditional banking, the goal is to create something immanently better.

Is this political?

Yes, a little. Today's system of money creation distorts capital allocation. To illustrate the problem, consider the example of a farmer who is faced with the choice of planting apple trees or pear trees. Apple trees come with a return of 5% per year, and pear trees with a return of 7%. So the optimal allocation clearly is to go for pears. However, if the farmer needs a credit to finance her project and banking regulation only allow banks to recognize apple trees as collateral, then the farmer will actually go for apples. For example, if the interest is 3% and the farmer can borrow up to 75% of the value of the apple trees, the return on equity on the leveraged position is 11%. That way, apples become the rational choice, even though it would be better for society to plant pear trees.
That's how the regulators that define capital requirements for banks implicitely influence the resource allocation of the economy, leading to a worse outcome than in a free and open market. In particular, today's capital requirements push exorbitant amounts of capital into real estate and government bonds. Next in line are large corporations, followed by smaller business. Venture capital and crypto projects are at the very bottom of the food chain. Fortunately, blockchain technology offers a way out. It allows us to to try to build something better outside the broken traditional financial system. With the Frankencoin, we want to return the power of the creation of the money to the people, enabling anyone to mint their own cash. This can lead to a stronger economy and more growth, if the system is used responsibly.

Is the Frankencoin a security?

We do not think so. It does not qualify as a security under Swiss law as it does not represent a claim towards an issuer. Also, it does not pass the American "Howey Test" as buyers of Frankencoins do not expect a return from holding it.

When obtaining Frankencoin against a collateral, is that really borrowing?

We are having an ongoing debate on whether the term "borrow", "mint", or something entirely different should be used. "Borrow" is more intuitively understandable, but it implies the presence of a counterparty and by extension that the Frankencoin system is a legal entity - which it is not as the law does not recognize distributed systems as such. Also, the term "borrow" is usually applied to things that already exist before they are being borrowed. So the alternative term that could be used is simply "mint", which is technically correct as that is what happens when obtaining Frankencoins against a collateral: new tokens are being minted using the mint function of the Frankencoin smart contract. However, the term "mint" does not cover everything that is happening, so while it is more accurate than "borrow", it is less complete. "Borrow" correctly implies that at some point in time, the created Frankencoins need to be returned, which "mint" does not. Given the choice between the more complete but slightly misleading "borrow" and the more accurate but incomplete "mint", we decided to label the according buttons "borrow".

Are Reserve Pool Shares securities?

Maybe. Functionally, they resemble shares in an enterprise. They allow holders to participate in the profits the Frankencoin system makes, expose holders to its risks, and allow them to participate in a governance process. These are typical functions of equity shares. However, formally, reserve pool shares do not represent securities as there is no identifiable issuer. So a regulator following the "function over form" approach might conclude reserve pool shares to be securities. However, this would create all kind of hairy legal questions as most securities laws have been written with traditional securities in mind that represent a claim towards an identifiable issuer. In the long run, legislators will have to figure out whether to create new laws designed designated to crypto assets (the European Union is in the process of doing so with their MiCA regulation) or whether they want to make existing securities regulation applicable to functionally similar crypto assets.
Last modified 11mo ago