Editing Chit Fund DAO (section)

== Background ==
A [[wikipedia:Chit_fund|chit fund]] is a folk banking scheme, traditionally used by people without access to formal banking institutions. The term ''chit fund'' comes from India, where it has been used by a significant percentage of the population for many years, and is legally regulated in many regions. Similar [[wikipedia:Rotating_savings_and_credit_association|decentralized savings and credit schemes]] are used throughout the world to replicate the functions of banking, especially where people do not have access to centralized banking institutions.

Banking involves two money processes: deposits and withdrawals. The specific sequence determines the type of banking. Consider, for instance, the fundamental banking practices of loans, investments, and insurance. A ''loan'' is an initial withdrawal of money followed by a series of deposits. An ''investment'' is a series of deposits, followed by a withdrawal. ''Insurance'' is a series of deposits, with a withdrawal at random times between the deposits. These three types of banking are unified by the scheme in a basic chit fund, as illustrated next.

=== Basic chit fund scheme ===
In a traditional chit fund there are several subscribers and an organizer. As a basic example, suppose 50 subscribers agree to deposit $200 (the premium) in the fund every month for 50 months. Each month an auction takes place, where the subscribers can bid to receive a fraction of the current total chit fund. The lowest bid gets to keep the amount they bid. Any remaining money is held over for the next month's auction. Once you win an auction, you can’t win another, but you are still required to add your $200 each month until the end. So the number of subscribers is always equal to the number of months the chit fund runs in traditional chit funds (though this stipulation is removed in the generalized cfDAO).

In this example, notice that $10,000 is added to the fund each month for 50 months (<math>$200\times 50</math> members, unless someone defaults). For $200 entry you can withdraw almost $10,000 in the first months, if you bid lowest. Early winning bids will typically be from people eager to use the chit fund as a loan, so they will typically be lower than $10,000. Since the excess money remains in the fund for later bids, the fund typically grows, in which case it holds more than $10,000 later. Therefore, early withdrawal is analogous to taking a bank loan that is repaid for 50 months with interest. Later withdrawal is similar to a bank deposit that earns interest. Others can use the fund as insurance by withdrawing when they need it at any time between the beginning and the end.


However, the core difficulty in implementing any chit fund is organizing it. The primary threat is that a subscriber will win an early bid, then fail to make the rest of the deposits--defaulting. Traditional chit fund organizers make a 5% commission, for the primary goal of ensuring subscribers do not default. This is especially challenging in a decentralized, open, global financial scheme. How can we guarantee the default rate is low enough to justify participation from pseudonymous participants? To solve this problem, the chit fund needs to be insured against the risk. Therefore, the subscribers of the cfDAO require underwriting.