A frequent criticism of monetary policy is that it tends to be reactive. Fed policy is determined by members of the Federal Reserve, who are all political appointees. Even if political concerns were not an issue, increasing or reducing the money supply in the economy is a slow process that stretches out over several months, and previous decisions often leave the Fed unable to pivot in response to new market factors. The Fed’s first recourse to reducing the money supply is to increase the discount rate — the interest rate that Fed charges when it makes overnight collateralized loans to depository institutions. The increased discount rate subsequently impacts the federal funds rate, which is the interest rate that depository institutions — banks, savings and loans, and credit unions — charge each other for overnight loans. Finally, this peters down to corporations and consumers who now have to pay higher interest rates to borrow from depository institutions, making debt less attractive.

A smart-contract-based borrowing and lending model has the ability to dynamically adjust risk in response to market conditions without the inherent delay that current monetary policy is predicated on. On-chain transparency combined with Oracles has the capacity to dynamically adjust rates in response to market conditions, and updated forecasts, without waiting for monthly Federal Reserve meetings which often respond to events of previous months. Secondly, lending through traditional depository institutions involves human review and approval. Not only can this involve human bias, but also lenders calibrating asset quality to Fed policy often find it difficult to establish values in illiquid markets. Additionally, individual depository institutions only disclose their lending activities in quarterly filings and do not disclose the creditworthiness of their borrowers.

In sharp contrast, blockchain transparency and smart contracts are a much easier way to determine the market value of borrower assets and the amount of debt in the system. Subsequently, based on a public set of parameters, smart contracts can dynamically adjust borrowing requirements based on this data in real-time leading to more adaptable and resilient markets.