Interest based lending is a cheaper and more predictable alternative to fractional title transfer for a payments system

To understand interest rates we must visualize a payment system without them

The simplest generalized model of a payments system is not fractional reserve, but rather fractional title transfer. If we ambitiously first assume fixed and stable relative asset prices, then fractional title transfer is the idealized payment system.

Any real asset can be used to make payments, not simply an arbitrary commodity like gold. Relying on a commodity payment system reflects a lack of imagination in designing the payment system.

For fractional title transfer, you simply transfer shares of ownership rights to any real asset to make payments. If you have a yacht or a private jet for example, valued at $30 million or $3 million respectively, then you can issue 30,000 yacht shares at $1,000 each, or 30,000 jet shares valued at $100 each.

There is no interest based lending required for a fractional title payment system, and more importantly we do not have to rely on a singular commodity like gold, which exposes us to incredible price risk.

While if you assume fixed and stable prices, a fractional title system is great for making payments, but in the real world this faces two significant obstacles-- prices are extremely unstable, and transferring ownership of real assets is difficult and expensive.

So this is why we use interest based lending for payments. The costs are relatively minimal and predictable, and as debts are repaid the original owners maintain possession and ownership.

There are two kinds of discounting performed in this system. One is the costs of monetary lending, expressed as an interest rate, and the other is in terms of credit limits from appraising collateral, which ideally needs to cover the costs of asset recovery and transfer in the case of default.

So if both discounts are calculated accurately, then lenders profit over both contingencies, whether or not the borrower defaults.

The reason why interest rates rise in a payments crisis, is because the price that assets can be sold for directly to cover payment obligations falls. But importantly owners still expect those asset prices to recover. This is why they are willing to accept a higher rate: they prefer to incur the additional interest expense, rather than being forced to sell an asset at a temporarily depressed price.

The use value of assets can be calculated as rental income to owners, whether they assess this benefit for their own use, or delegate that use out to someone else renting the asset.

This is also the function of money in a payments system which runs on interest based lending. Those who have liquid assets, which can trade or circulate large volumes with minimal price impact, rent out those liquid assets to people who hold less liquid assets. Collateral is the pledge used to guarantee rental of liquidity. The down payment represents a buffer between an appraised price, and the credit limit or amount of liquidity available.