Cycles Protocol: A Peer-to-Peer Electronic Clearing System

TL;DR

The paper introduces Cycles, a decentralized protocol that improves liquidity and reduces costs for small firms by enabling efficient, privacy-preserving multilateral settlements using diverse assets and graph optimization.

Contribution

It presents a novel open, decentralized clearing system leveraging cycle-based liquidity access and graph algorithms to address real-world payment inefficiencies.

Findings

Enables firms to settle more debt with less capital.

Reduces working capital costs for small enterprises.

Provides a privacy-preserving, scalable settlement platform.

Abstract

For centuries, financial institutions have responded to liquidity challenges by forming closed, centralized clearing clubs with strict rules and membership that allow them to collaborate on using the least money to discharge the most debt. As closed clubs, much of the general public has been excluded from participation. But the vast majority of private sector actors consists of micro or small firms that are vulnerable to late payments and generally ineligible for bank loans. This low liquidity environment often results in gridlock and leads to insolvency, and it disproportionately impacts small enterprises and communities. On the other hand, blockchain communities have developed open, decentralized settlement systems, along with a proliferation of store of value assets and new lending protocols, allowing anyone to permissionlessly transact and access credit. However, these protocols remain used primarily for speculative purposes, and so far have fallen short of the large-scale positive impact on the real economy prophesied by their promoters. We address these challenges by introducing Cycles, an open, decentralized clearing, settlement, and issuance protocol. Cycles is designed to enable firms to overcome payment inefficiencies, to reduce their working capital costs, and to leverage diverse assets and liquidity sources, including cryptocurrencies, stablecoins, and lending protocols, in service of clearing more debt with less money. Cycles solves real world liquidity challenges through a privacy-preserving multilateral settlement platform based on a graph optimization algorithm. The design is based on a core insight: liquidity resides within cycles in the payment network's structure and can be accessed via settlement flows optimized to reduce debt.