Endogenous Money Theory

Discussion

Yongseun Kim:

"Endogenous money theory, rooted in Post-Keynesian economics, argues that the supply of money is determined by the demand for credit within the economy. In this framework, money is created endogenously as businesses and consumers demand loans, and commercial banks respond by issuing credit. This contrasts with the classical view that money supply is exogenously controlled by the central bank.

In the context of the crypto ecosystem, the concept of endogenous money finds a direct parallel in decentralized finance (DeFi) systems, where token supply is created based on the demand for borrowing and lending within the network. This reflects the Keynesian emphasis on effective demand, as these systems create tokens (and liquidity) in response to user activity, much like traditional banks create money when they issue loans.

For example, in platforms like Sky (formerly MakerDAO), new DAI stablecoins are minted when users lock up collateral (e.g., Ethereum) and borrow against it. The more demand there is for DAI, the more of it gets created, which mirrors the endogenous creation of money in traditional banking. This mechanism highlights how effective demand in the crypto space drives the creation of liquidity, similar to how demand for loans drives money creation in the traditional economy. However, with Sky’s introduction of USDS, a fiat-backed stablecoin, we see a dual approach: DAI reflects the endogenous creation of liquidity, while USDS represents a more traditional, exogenously managed stablecoin model.

The Keynesian focus on effective demand is also relevant to the liquidity mechanisms in DeFi. Just as Keynes advocated for government intervention to maintain demand during downturns, DeFi platforms must ensure adequate liquidity to support lending and borrowing activities. If liquidity dries up — due to market shocks or a collapse in demand — the entire system can face a credit crunch, similar to what occurs in traditional financial crises.

By understanding the role of effective demand in both traditional and decentralized systems, we see how endogenous money theory applies to crypto ecosystems. In both cases, liquidity is created in response to demand, but in the crypto world, this process is governed by smart contracts and decentralized protocols rather than central banks and commercial institutions.

In both the case of CBDCs and crypto ecosystems, the Keynesian focus on effective demand and endogenous money creation offers valuable insights. Whether through direct interventions via CBDCs or decentralized mechanisms in DeFi, maintaining liquidity and ensuring adequate demand remains central to the health of any monetary system. This focus sets the stage for the conclusion, where we explore how traditional and decentralized systems can be integrated to create a more resilient financial future."

(https://medium.com/@deframing/the-meaning-of-monetary-economics-in-the-crypto-world-e7f89e60d3a3)