Unless you’ve been living under a rock, you’ve probably heard about what happened with Silicon Valley Bank (SVB). I don’t want to bore you regurgitating everything that went down, but what I want to do instead is try and figure out how we got ourselves into this mess to begin with.
First, let’s try to understand why we need banks at all. When we deal with physical dollars, the main concern is the potential for counterfeit bills to enter the money supply. When you’re dealing with digital dollars, you’re faced with the same problem but with a different solution.
With physical currencies, the solution is to make them hard to counterfeit. This is why the process of making dollar bills is so intricate using complicated techniques with very specific materials. It makes it difficult and expensive for anyone outside the US Mint to do successfully. But of course none of that applies when talking about digital forms of money, which are nothing more than numbers in a database that represent your account balance.
Which brings us to something called the double-spend problem. The double-spend problem doesn’t exist for physical currencies, because once you’ve handed someone a dollar bill, you no longer have that dollar bill to use again. But what if we’re talking about money that’s digital rather than physical? Think about an mp3 file of your favorite song. You can easily send it to as many people as you want, as many times as you want, which isn’t something you’d want people to be able to do with their money.
This is why we have banks and other financial institutions that act as trusted third parties to ensure the money Bob is using to pay Alice is legitimately sitting in his account and hasn’t already been spent.
If you think about it, the double-spend problem is why we’re forced to rely on these financial institutions for all of our online payments. As such, we have no choice but to give up our identities, and with it our privacy, along with our ability to take custody of our own hard earned money. So that leaves us with no choice but to rely on someone else to safeguard our funds. This weekend a friend of a friend went to his local bank to transfer everything he had in excess of $250K, and the bank manager made it as difficult as possible for him. How ridiculous is it that it’s so hard to do what you want with your own money?
Sure, you could theoretically store a million dollars in cash under your mattress, but good luck using that to pay for your Uber ride, or for your next Amazon order.
Another problem with banks most people don’t think about is how much they cost to run. You have to pay for the buildings, the utilities, the employees, not to mention the interest they offer to incentivize new customers to open an account with them. Banks pay for all those costs by taking your money and using it to invest in things like mortgage backed securities, or treasury notes, in addition to lending it out for home, car, or small business loans. This is how banks make money, and it’s what’s known as fractional reserve banking since the banks only keep a fraction of the total deposits on hand at any given time.
The concept of fractional reserve banking has been around for centuries. It benefits the economy by providing additional liquidity to the system and using the capital to grow and stimulate the economy rather than just letting it sit idle. But as we saw with SVB, fractional reserve banking comes with its own set of problems. What happens if there’s a run on the bank and everyone suddenly wants their money at the same time? What if the people they lent the money to default on their loans? And if the overall economy begins to struggle, fractional reserve banking can lead to a domino effect that takes down not just one bank but many.
But what if there was an alternative to all of this? If we could just make online payments without the need for such trusted third parties, or if there was a way to easily and conveniently take custody of our own funds without needing a bank to do it for us, wouldn’t that be so much better? Well, that’s exactly what Satoshi Nakamoto made possible when he created Bitcoin.
By leveraging blockchain technology, cryptocurrencies like Bitcoin and eCash give us the ability to have an online payment system that doesn’t require any intermediaries. This has all kinds of ramifications that even the people on crypto twitter don’t seem to realize. For one, it means we can have a system where we don’t have to give up our identities in order to use our money online. Another benefit is that because cryptocurrency networks facilitate peer-to-peer payments, no one can censor your transactions. Paypal was recently in the news for threatening to do exactly this and even going so far as to confiscate your funds for having the wrong opinion. The whole point of crypto is to be able to circumvent these kinds of institutions. The legacy system also has exorbitant processing fees, the threat of customer chargebacks, plus the fact that it can take days or weeks for a traditional credit card payment to settle into a vendor’s account.
Now let’s imagine a world that runs on cryptocurrencies. By enabling people to safely take custody of their own money, it makes it possible for us to hold banks accountable in a way that we couldn’t before. We will no longer need central banks since our money is no longer printed out of thin air but produced by proof of work. And while I think there will still be the need for commercial, retail, and investment banks, I envision a banking system that is radically different from the one we have today. Because people will no longer need banks in the same way, every bank will have to demonstrate the value they bring to the table rather than playing games and coming up with these opaque products that try to take advantage of their customers rather than serve their customers. Some banks might specialize only in safely storing your funds so it’s always on hand in case you need it. For this they could charge you a small fee that gets deducted from your account each month. There may be other banks that offer yield on your deposit, but I’m hopeful that since everything is on chain, we can have greater transparency and an increase in confidence that they are allocating the capital properly.