Rethinking Money Creation As Private Credit Tokenization Surges

As blockchain evolves and nonbank private credit expands, money creation through traditional bank lending is losing ground. This shift challenges the fractional reserve banking system, highlighting the need to rethink money creation as private credit tokenization becomes more prevalent in our economy.

Why Rethink Money Creation？

The tokenized asset market is projected to grow to $4 to $16 trillion by 2030, according to reports by Boston Consulting Group and McKinsey & Company. Tokenization enhances liquidity, fractional ownership, and investor participation while accelerating the decline in bank lending, driven by securitization and private credit growth since 2008. Individuals control over half the worlds $290 trillion in wealth, with only 5% in alternative investments. Blockchain-driven tokenization could boost this to 20%, expanding the market by trillions.

In a new paper, professors at Harvard and Duke highlight how Corporate America is increasingly funded by private credit from dispersed, passive investors rather than banks, reflecting a democratization in corporate funding. They argue that the $1.5 trillion private credit market has shifted companies' discipline in debt funding from traditional banks to trading markets. Fed data shows direct lending has grown 17-fold since 2009. Meanwhile, loans as a share of bank assets have dropped from 70% to 55% since 1970. These trends signal a shift that sidelines traditional bank loans and transforms the foundation of our economy's money creation.

Is Fractional Reserve Failing？

In this new reality, the fractional reserve system seems increasingly ill-suited to support these developments and could even hinder economic growth. Heres why:

When banks issue loans, they don‘t just lend out existing money but create new money by generating deposits in the borrowers’ accounts. This process increases the money supply because the loan becomes a new deposit that can be spent in the economy. In contrast, direct lending and nonbank private credit funding simply reallocate existing money without generating new deposits, leaving the money supply stagnant even as economic output grows. This decoupling can lead to deflationary pressures, as the same amount of money chases an increasing supply of goods and services. As private credit expands and blockchain-driven tokenization grows, the dynamic between money creation and economic activity changes, potentially exacerbating this decoupling.

Why Is Decoupling A Risk？

The risk of decoupling between rising economic output and a stagnant money supply could contribute to deflationary pressures. This scenario occurs when more goods are produced without a corresponding increase in the money supply to purchase them, potentially leading to economic stagnation. Japans persistent deflation in the 1990s, driven by a sluggish response to rising private credit without sufficient money supply growth, underscores the challenges of a mixed financial system. Similarly, during the Great Depression, the misalignment between economic activity and a shrinking money supply led to severe deflation and prolonged hardship.

Should We Embrace Tokenization？

Recent Federal Reserve notes discuss how monetary policy effectiveness weakens in the context of private credit compared to traditional bank credit. Society must consider its options as banks lose ground to private credit and blockchain technology. One approach is to counter these trends with regulations and bans. However, a more forward-thinking strategy would embrace these changes, harnessing technological advancements for positive transformation. We should reconsider economics through the lens of increased tokenization, which will likely dominate the financial landscape in the coming years. This shift presents an opportunity to enhance a financial system long vulnerable to instability. Rather than resisting the inevitable evolution of finance, now is the time to re-evaluate and upgrade our money creation system to fit the emerging realities of a digital, decentralized economy.

How Must Money Evolve？

As the modern financial landscape evolves, it seems clear that an upgrade to our money creation system is needed. In the 18th century, Adam Smith, often called the father of economics, and his close friend David Hume, a renowned Scottish philosopher and historian, laid the theoretical foundations for the fractional reserve banking system. They believed banks, with their deep understanding of economic activity, were well-positioned to manage the money supply.

However, the world has changed dramatically since their time. With the rise of private credit, securitization, blockchain-based tokenization, and the diminishing role of traditional banks, it is time to rethink these centuries-old ideas and adapt to the 21st century.