Transferability, finality, and debt settlement

Payment, fundamental to exchange in a decentralized economy, often takes the form of transfers of inside money, i.e., specialized forms of debt. Associated with each type of inside money is a set of rules that governs both the legitimacy of such transfers as means of extinguishing other debts, and the allocation of the ensuing risks. In this paper we develop a model of debt as inside money. In a simple mechanism design framework we show that transferable debt that can be used to settle other debt obligations with finality can be a welfare improving arrangement in the presence of limited enforcement powers. Transferable debt has two advantages over simple chains of credit: it allows for removal of less-thanperfectly reliable agents from the chain in a timely fashion, and it allows agents to direct payments to the proper party without direct communication with other members of the credit chain. r 2006 Elsevier B.V. All rights reserved