Banking doesn’t require Banks

When Satoshi Nakamoto released the Whitepaper for Blockchain technology and Bitcoin, he did it with the intention of creating a decentralized payment system that works on a peer-to-peer network sharing protocol. Blockchain technology is the network which facilitates transactions for bitcoin and other cryptocurrencies. The highlight of the technology was to present a system based on ‘trust,’ that operated devoid of a centralized authority.

Image by Tumisu from Pixabay

However, the disruptive nature of this technology in relation to the economy, as well as financial and banking services created a gap in the mission of bitcoin. This system, over time, has shown a number of merits and demerits — but the mission of bitcoin is facing barriers to ubiquity due to the skeptical nature of various governments, not willing to get onboard with decentralization.

The skepticism can be attributed to:-

Understanding the Content

The blockchain network and cryptocurrency exchanges have their basis in cryptography. Merely trying to understand the processes involved in it can be an arduous task. Imagine trying to incorporate this technology into a larger economic framework based on centralization.

This technology has the ability to cause a paradigm shift in economic and financial services. However, for this technology to be successfully implemented into the larger scheme of things, it is important to get on board with understanding blockchain technology and cryptocurrencies, as a whole — to be able to successfully be used by entities, both people and organizations.

Fear of the Unknown

Banks and other financial institutions charge a high rate of interest on loans, as well as recurring transaction, service and maintenance fees, among other things. These institutions often make high levels of profits, sometimes at the cost of the customer. The 2008 financial crisis gave rise to the need for transparency and accountability, leaving financial experts and academicians to look for a reasonable solution.

Blockchain technology facilitates new and innovative processes that cannot be modified retroactively without being verified by a majority of the network. This provides a considerable amount of transparency and operational efficiency to users. It also eliminates the need for intermediaries charging high transaction fees, which generally increases the time taken to execute transactions.

Banks and financial institutions are the backbones of the traditional economic structure which a significant part of the world is still dependent on. The move to blockchain technology and cryptocurrency trading strikes fear at the heart of these institutions. Banks generate large amounts of profits from transaction fees and high rates of interests charged on loans. They stand to lose these generated revenues because of blockchain’s decentralized trading on p2p networks.

Ripple’s Entry into this space

Ripple exists to solve these problems posed to banking institutions. It is the third largest cryptocurrency, after Bitcoin and Ethereum. It has a market cap of over $12 billion and trades at around $0.30, as of 30th April 2019.

Ripple is considered to be a digital asset for payment transactions. The XRP token mainly helps enterprises and banks for payment transactions at a faster rate with minimal transaction costs.

Ripple’s model is based on partnerships with banks to solve for cross-border payment issues associated with bitcoin. Its purpose is to solve for the aspect of inflation as a result of fiat currencies being pumped into the economy. It also solves for geographical issues by providing real-time global payments across 27 countries.

Bitcoin’s framework removed the need for centralized banking, for the provision of financial services. The framework shed light on the fact that; While financial services are necessary, financial institutions aren’t.

According to Bill Gates, the principal founder of Microsoft, “We need banking, but we don’t need banks anymore.”

How do you Facilitate Banking without Banks?

I believe we need to find a middle ground between the vision of bitcoin, and the actual prevailing situation of regulatory hurdles, low network hurdles in blockchain solutions, etc. The goal should be to create actual value as a medium of exchange and as a store of value.

There are multiple companies out there that aren’t banks but facilitate banking and financial services. Without a centralized regulatory authority, how does one ensure that customers pay back the amount they’ve borrowed?

The first way to ensure this would be to operate within the banking system itself. If customers don’t pay back the loan amount, it affects their credit scores.

The second way to do this would be to ensure that companies have some security in place, that they can liquidate in the event of a shortage.

The problem with this is the fact that credit score data is subjective, prone to errors and inaccurate. Since it is a subjective parameter, it is not a good metric and hence, it isn’t a reliable one at that. Most people have their credit scores affected due to mistakes. Furthermore, credit score data isn’t the most secure since credit score companies get hacked all the time. For example, in 2017, Equifax had undergone one of the largest security breaches in history where over 140 million users’ data had been stolen by an unidentified thief.

What, then, would be a Viable Solution to Ensure Effective Repayment of Loans?

The first step would be to ensure that the loan is collateralized if they can be. The loan would have to be collateralized against cryptocurrency assets. Assets in the form of cryptocurrencies would replace the funds going out of the company in the form of loans.

The second step is pre-emptive in the sense that customers who don’t own the right assets cannot avail these services.

The collateralized system would be able to give a far better user experience. It would allow a company to be objective in the way they offer their services.

The best sort of collateral would be one where the price can be understood on a dynamic base, where we can understand their volatilities in terms of Loan to Asset Value (LAV). The items that are considered as collateral against loans are equities held in national or international exchanges, national or treasury bonds, and cryptocurrencies.

In regards to equities and bonds, one would need to buy it while operating under stringent rules by the national centralized financial authority, where one can argue that these rules protect the customer- which is mostly true. This, however, defeats the purpose of operating without a centralized authority.

The only logical thing to offer is crypto-backed financial services. It still doesn’t solve for the decentralized approach that bitcoin was trying to foster.

The next best thing is to distribute the firm’s profits amongst token holders, put out the transaction data on the public ledger of the tokens, facilitate these financial services through decentralized applications, and ensure that the firm isn’t the middlemen in any of these services.

This is as close to Satoshi’s vision that can work without having to rely on any particular coin or currency becoming the ubiquitous international one.

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