What follows is a description of the 4 stages of implementation of a decentralized exchange of value, starting with simple barter and ending with a robustly liquid market with totally decentralized monetary authority.  This system is currently at stage 2 of implementation and is geared toward use by mobile devices such as the iPhone, Blackberry and Android phones.

STAGE 1) BARTER EXCHANGE WITHOUT CURRENCY

Everyone knows what a simple 2 way barter is.  No currency or money are involved.  There is a simple exchange of things that people want that they don’t have themselves.  In our electronic barter system, there is an additional feature that facilitates negotiation:  The computer serves as a “middle man” who takes in secret bids and asks, and, without revealing anything to the trading partner, decides whether there is a deal here or not—and if so how to divide up the profit that would normally be kept by the middle man.

Here are some examples:

TWO PARTY BARTER REBATE CASES:

spread = bid-ask
rebateToBidder = spread*bid/(bid+ask)
rebateToAsker = spread*ask/(bid+ask)

CASE 1:
john bids 1 gross eggs for 1 haircut
jane bids 1 haircut for 1 gross eggs

spread on both is 0 so both rebates are 0.

CASE 2:
john bids 2 gross eggs for 1 haircut
jane bids 1 haircut for 1 gross eggs

gross eggs spread is 1, so:
rebateToJohn = 1 gross eggs * 2 gross eggs/(3 gross eggs) = 2/3 gross eggs
rebateToJane = 1 gross eggs * 1 gross eggs/(3/gross eggs) = 1/3 gross eggs

haircut spread is 0 so there is no haircut rebate

CASE 3:
john bids 2 gross eggs for 1 haircut
jane bids 2 haircut for 1 gross eggs

gross eggs spread is 1, so rebate the same as case 2.

haircut spread is 1, so:
rebateToJane = 1 haircut * 2 haircuts/(3 haircuts) = 2/3 haircut
rebateToJohn = 1 haircut * 1 haircuts/(3 haircuts) = 1/3 haircut


THREE PARTY BARTER REBATE CASES:

spread = bid-ask
rebateToBidder = spread*bid/(bid+ask)
rebateToAsker = spread*ask/(bid+ask)

CASE 1:
john bids 1 gross eggs for 1 haircut
jane bids 1 haircut for 1 pound shrimp
dave bids 1 pound shrimp for 1 gross eggs

spread on all is 0 so all rebates are 0.

CASE 2:
john bids 2 gross eggs for 1 haircut
jane bids 1 haircut for 1 pound shrimp
dave bids 1 pound shrimp for 1 gross eggs

gross eggs spread is 1 between john and dave, so:
rebateToJohn = 1 gross eggs * 2 gross eggs/(3 gross eggs) = 2/3 gross eggs
rebateToDave = 1 gross eggs * 1 gross eggs/(3/gross eggs) = 1/3 gross eggs

haircut and shrimp spreads are 0 so there are no haircut or shrimp rebates

CASE 3:
john bids 1 gross eggs for 1 haircut
jane bids 2 haircut for 1 pound shrimp
dave bids 2 pounds shrimp for 1 gross eggs

the spread is 1 for both haircuts and shrimp, so (leaving out the, by-now, redundant math):
Jane’s gets 2/3 haircut and Dave gets 1/3 haircut rebate.
Dave gets 2/3 pound shrimp rebate and John gets 1/3 pound shrimp rebate.

CASE 4:
Leaving out even more description, all spreads are 1, so:
All bidders receive rebate of 2/3 of the spread and all askers receive rebate of 1/3.


STAGE 2) BARTER EXCHANGE WITH PERSONAL CURRENCY

With “personal currency” all bids and asks are stated in terms of a monetary unit one controls, as though one were a sovereign nation with one’s own internal economy.  All products of the “nation” are offered for “sale” at an asking price denominated in the “nation’s” monetary unit.  Likewise, when bids are made, they are also made in one’s own monetary unit.

This seemingly minor change in the Stage 1 economy not only facilitates the division of spread-rebates previously described, it allows an individual to offer more than one item for sale in a single trading unit controlled by that individual “sovereign”.

For example, imagine that John has not only chickens that lay eggs, but he has dairy cows from which he obtains milk.  Rather than placing two bids for a haircut, one in terms of eggs and another in terms of milk, he may prefer to place one bid for a haircut in terms of “Farmer John’s Dollars”, and then ask a minimum of 1 per dozen eggs and ask a minimum of 2 per gallon of whole milk.  The spread calculations would proceed as before except in terms of personal currencies rather than fractions of actual goods or services.


STAGE 3) THIN MARKET PERSONAL CURRENCY EXCHANGE

Since at Stage 2, the “exchange rate” specified is only between items within a person’s own “nation” (say between the goods offered by John from his farm, etc.) there remains the obvious step of establishing exchange rates between personal currencies.  In one sense, this is the same problem as establishing international currency exchanges, but the practicalities are far different and, in 2 ways, even more challenging:

a) Individuals (and even small businesses) traffic in the end items of trade—haircuts, eggs, milk, shrimp, etc., and any imposition of the notion of a “currency exchange” is only going to get in their way.

b) Even if they could tolerate a personal currency exchange, the resulting market would have so few bids and asks for various personal currencies that it would be difficult to establish reasonable exchange rates between arbitrary currencies.  This is the problem with all markets in which there is a “thin” supply of bids and asks.

Fortunately, there is a way to meet each of these challenges in a way likely to be acceptable to individuals and small businesses:

A) When a personal currency bid is made for an end item, there is a partial sense in which the bid represents a currency exchange, since the item has an asking price denominated in the seller’s personal currency.  It is only partial, of course, since there is nothing necessarily tying the seller’s currency back to the bidder’s currency—so the seller could ask arbitrarily high, or low, amounts of his own currency with no clear way of establishing an exchange rate.  However, if there is a way of imputing a reciprocal bid by the seller for something offered by the original bidder, a corresponding exchange rate might be imputed with the same degree of confidence as that imputated bid.

B) This thin market imputation is the same problem as that faced by “recommender engines” increasingly used by online businesses, where the service provider predicts what a customer is going to prefer among its items for sale.  In technical terms, this is called “imputation of missing data”—and the recent technical advances in this area have been impressive, with, for example, Netflix recently awarding a $1 million prize to a team of artificial intelligence experts who substantially improved the accuracy of their movie recommendations.

With such powerful imputation algorithms over sparse tables of data, reasonable imputations of personal currency exchange rates are possible despite the thin market.


STAGE 4) CREDIT CLEARING WITH EMERGENT UNITS OF ACCOUNT

The obvious final stage in establishing a robustly decentralized value exchange is the creation of liquidity through the issuance and clearing of credit to compensate for incomplete barter cycles.  This is made possible through the exchange’s retention of rebates, denominated in the various personal currencies, for the purpose of compensating traders who are temporarily short-changed in the execution of partial barter cycles, as well as charging traders who are temporarily advantaged.  The rebate formula is geared toward a completely-settled barter-cycle.  However, the rebates are not issued immediately by necessity since to do so would telegraph the market positions of various traders, there by reducing the incentive to ask low and bid high, hence reducing the fundamental liquidity of the exchange.  This delay can therefore serve a dual purpose:

a) Maintain secrecy of market positions to promote fundamental liquidity.
b) Provide a grace-period within which the cycles may be completed and temporary lines of credit cleared.

The result of this sort of exchange is the market-driven emergence of dominant units of account that meet the criteria set forth by Thomas H. Greco, Jr.:

* Traded in several relatively free markets.
* Traded in relatively high volume.
* Important in satisfying basic human needs.
* Relatively stable in price over time.
* Uniform in quality or amenable to the application of quality standards.

This will occur as traders find they are more-often rewarded when they establish bids and asks for such commodities in terms of their personal currencies, thereby supporting the thin-market exchange rate imputations.