Transferability, Finality, and Debt Settlement

The process of payment is fundamental to exchange in a decentralized economy. In production economies, payments often take 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 the authors develop a model of debt as inside money. They focus on an historically important form of payment: “negotiable instruments” such as the bill of exchange. In a simple mechanism design framework the authors show the advantages of transferable debt over simple chains of credit. The model is then extended to encompass other aspects of negotiability, including “endorsement” and the rights of a “holder in due course.” JEL classification: E400, G200, K200