The Emergence of Banks

The first post in this series will feature why we use traditional commercial banking services to begin with.  This will be a quick primer and won’t delve into the history of banking but highlight some of the underlying elements of why we have banks.

The reason I want to start with this is because commercial banking is the financial service that the majority of people use on a day-to-day basis and any blockchain or cryptocurrency (B&C) technology that is developed will need to do so in a way that can provide an alternative but like-service as modern day commercial banking does.   The main services that commercial  banking provides has evolved over time to really provide solutions to some of the following problems.

MONEY

Firstly, we must understand that banks primarily hold our money. Today, most people set up a direct deposit of their paycheck into their bank accounts which is what the majority of people use banks for: storage for their money. A bank can be used to store other valuable goods, but for now, we will only focus on money.

What is money? It is essentially a medium of exchange that allows for two or more parties to transact without having to exchange their own products or services directly. For example, if I am an accountant, I can work for a company that needs an accountant and they will pay me money. Now, say I go to the local food market and purchase some vegetables. I do not have to directly perform accounting services for the food market vendor in order to purchase the food. I can use money as a means of consideration for that transaction. Likewise, that food market vendor can now use that money to purchase a new pair of jeans. She does not need to exchange her fresh produce with the jeans retailer in order to make the purchase.

NOTE: For this post, we will assume that we are in a society that uses sound money which cannot be heavily influenced by a central actor. Basically, just pretend our traditional banking money is gold or backed by gold. This is to limit the amount of exceptions that can be argued in regards to fiat monetary systems.

So what are the features that make banks so attractive to people with money?

SECURITY

A bank comparative to your residence is like a fortress.  Throughout history, banks have been designed to withstand attacks from theft and destruction.  Would you rather have all of your earnings and life savings maintained within your home where it could be more easily subject to thieves because of improper security features, and disasters like flood or fire?  Or, would you rather keep it at a bank that was designed specifically to provide 24/7 security monitoring and risk mitigation to keep your money safe at all times?

INSURANCE

A bank’s account of record for your funds is verifiable where as funds maintained at your residence would not be considered verifiable.  In an event of theft or destruction, your funds maintained at a bank could be replaced (through FDIC or NCUA insurance backed banks/credit unions) as a normal, and relatively inexpensive feature.  Funds maintained at your home would need to be insured through your home policy, or additional insurance policy, and that can get relatively expensive depending on the amount of money you are trying to cover. Insurance is another example of a security feature that banks provide.

CONVENIENCE

As society has become more mobile and continues to increase its global transactions, it has become more convenient to keep your money at the bank.  This is because the banking system has evolved to become more globally connected and that network allows you to do your normal day-to-day banking at a local branch, but have access to your bank account practically anywhere in the world.  If this were not the case, whenever you traveled, you would most likely need to use traveler’s checks (less convenient, but with less risk), and before those, you would have needed to carry the total expected amount of money for your trip with you (way less convenient with high risk).  Since it has become easier to purchase items from across the world (thank you internet!) sending payment is much faster and more secure through your bank than sending money through the mail.  Sellers are also more likely to prefer methods of payment handled through your bank or other financial institutions.

So How Does B&C Handle These Service Features Offered by Traditional Banking?

Traditional banking offered an approach that allowed individuals the ability to reduce their own risks, security measures, and costs by assuming those responsibilities. By centralizing a group of individuals money, they could provide better security at a small cost to the individual. B&C primarily handles security through cryptography (private and public key encryption) and a distributed ledger (blockchain),with consensus and reward mechanisms, that is designed to be robust and hard to attack.

There is no FDIC insurance for B&C. You’ll notice a trend with cryptocurrencies that a lot of responsibility falls back on the individual. As long as you keep your private key secure and memorized, there should be no need for insurance.

Convenience for B&C is ever evolving. A lot has to do with user adoption. The success of any cryptocurrency relies heavily on metcalfe’s law regarding network effects. The more people who use it, the more valuable the network and whatever is creating the network are. There will be a strong positive correlation between the size of the network and the convenience factor. For cryptocurrencies, you need as many people as possible who will not only use cryptocurrency as a form of payment, but accept it as well.

Is There Room For These Basic Services Provided By Traditional Banking on B&C?

I believe there is. We first need to distinguish between central banking services and commercial banking services.

B&C emerged more out of a response to Central Banking practices (or malpractices based on your opinion). Traditional banking has been a service that has spanned millennia and through numerous attempts at different styles of central banking. I believe this points to an underlying need that traditional banking provides. Humans are risk and loss averse in nature. Having some form of third party who will share your risk and help avert losses will most likely always be considered needed or desirable to many.

Commercial banking not only provides that third party share in risk, it also provides additional benefits to society as well.  We can expect some form of commercial banking to continue, but we can also expect some changes.  Users will have the ability to partake, and potentially receive compensation, in more of the provided services by contributing to the security and utility of the network.  The banking fees for these services should also drastically lower since security measures will be replaced or supplemented by the built in blockchain and cryptography features that contribute to a more secure digital network.

I believe this highlights that sometimes, technology is easier to change than human behavior, and how humans behave in regards to storing their money might be the biggest hurdle for B&C adoption.