A look at banking in 2050
The genie has been let out of the bottle. Pandora’s box has had it’s lid ripped wide open. Cryptocurrency is here to stay, and it isn’t going away. The recent US dollar Tether controversy has sparked a lot of discussion about cryptocurrency and fractional-reserve banking. In light of this paradigm shift of cryptocurrencies, we need to zoom out and start to imagine what a cryptocurrency-based economy will look like. To do this effectively, we’ll need to leave our indoctrination behind and view things from an anarchist’s perspective.
The innovation that Bitcoin and other cryptocurrencies provide is the separation of money and state. Let me say that again, so it sinks in. The innovation Bitcoin and other cryptocurrencies provide is the separation of money and state. Simply put, Bitcoin is black market money. If the state didn’t use the financial system as a means of surveillance and control, we wouldn’t need cryptocurrency.
Cryptocurrency’s entire value proposition is the fact that it is decentralized, no person or organization (nation-states included) controls it, and it allows you to transact without requiring the approval of the state. There is a reason that one of Bitcoin’s earliest use cases was the sale of illicit goods on the dark web.
As it stands, under our current system, banking is a rent-seeking monopoly. The state and banks work together, and financial institutions have been grandfathered-in. Rent-seeking is defined by the Mises Wiki as “a concept used to describe the activity of individuals or firms who attempt to obtain or maintain wealth-transfers, primarily with the help of the state.” There have been volumes of criticisms of fractional-reserve banking written by people much smarter than me, but I’ll try to sum it up.
- Central banks have a monopoly on state-sanctioned counterfeiting.
- They alone get to print money and by doing so, systematically rob the wealth from the rest of us by devaluing the currency through inflation.
- It’s often referred to as the “hidden tax”.
- It’s why the rich get richer, by printing money they make all existing money less valuable, and they directly benefit from the Cantillon effect, while everyone else (those without special relationships with central bankers) does not.
Bitcoin, on the other hand, has a finite supply capped at 21 million coins. There will never be more than this. This presents a problem for the central banks who are used to employing extraordinarily lax monetary policy which causes the boom and bust cycles of economic chaos. This stems from the manipulation of the money supply and intervention in the free market’s natural self-regulating mechanisms to achieve equilibrium. We live in strange times, as usury has been totally normalized and accepted. In previous ages, it was considered a crime, and immoral by various religions. Originally, usury was defined as accrued interest of any kind. Now we have institutionalized usury, in the form of fractional-reserve banking.
In order for us to try and visualize what a banking system would look like based on a deflationary cryptocurrency like Bitcoin, we need to know what sound money is. Sound money is defined as “money that is not prone to sudden appreciation or depreciation in purchasing power over the long term, aided by self-correcting mechanisms inherent in a free-market system.” Mises meant sound money as money whose purchasing power cannot be impacted by politics. Traditionally, gold was our sound money. This is due to the fact that it has a very high stock to flow ratio. The world’s supply of gold is the result of thousands of years of human mining activity, and new gold discoveries are very insignificant in affecting gold prices because new discoveries are a very small percentage of the total supply.
Bitcoin was Satoshi Nakamoto’s attempt to create a digitally scarce asset that had a high stock to flow ratio which mimics gold’s quality as a scarce and precious metal. This is why he designed the block reward for miners who provide proof of work to secure the network. This high stock to flow ratio is also the motivation Satoshi had for the halvening phenomenon encoded into Bitcoin’s emission schedule of block rewards which miners earn. Next year, Bitcoin will surpass Gold’s stock to flow ratio and have less supply-side inflation than gold.
Precious metals have traditionally been the most marketable or saleable good and arose as a natural medium of exchange. This is because they fulfill all the properties of sound money. They are portable, fungible, divisible, nearly indestructible, and scarce. In order to understand what banking would look like on a Bitcoin-based financial system, we need to take a look back in history at how banking emerged under the gold standard.
So how did banking actually work under a gold-backed currency?
People originally began to store their gold with goldsmiths for security. The goldsmiths would issue a note for the deposit and charge a fee for storing the gold. Since gold was heavy and bulky and the notes were not, people began simply trading the notes as if they were the actual gold. Since the notes were much more convenient, the goldsmiths realized they could create notes for which they did not have gold, because people hardly ever came to redeem the notes for their actual gold. Thus fractional-reserve banking was born. The goldsmiths began printing notes and lending them out for interest. This first started under the Knights Templar during the Crusades and carried on through dynastic families of the Renaissance such as the Fuggers and Medicis.
In a gold-backed economy, the two main problems were measuring the gold and verifying that it is actually gold with the correct level of purity. The market’s response to these problems was the creation of mints. Mints arose as reputable manufacturers of coins which met a uniform standard of quality. For instance, a gold coin from a mint can be reliably counted on to contain one troy ounce of .9999 pure gold. People would send their gold to a mint, receive standardized coins in return, then deposit those coins with a bank, and use the bank notes which were issued from their gold coin deposit, as their actual currency.
Under this system, a bank-note was a promissory note representing a certain amount of gold deposited with a bank. It was a bearer instrument, which allowed anyone possessing the note, to redeem it for the amount of gold it represented. Bank-notes were often just used as cash since they were much easier to deal with than gold itself.
A check was an order to a bank to pay a specific person a set amount of gold. It was not a bearer instrument, it was just an order for a bank to pay a specified amount to a specific individual. A loan or credit, was a certificate like a note or check that was not backed by actual reserves which the banks would lend out at interest. These notes, checks, and credits are all money substitutes, known as fiduciary media. Fiduciary media is issued by a bank but not fully backed by metals. As the issuance of fiduciary media becomes more prevalent, the purchasing power of actual money decreases.
In a gold-backed system, someone who wants to save money could deposit their coin and gain interest. If the interest rate decreases, and it is no longer worth the risk of storing your coin with the bank, you could withdraw your deposit. This self-regulating free market force incentivized banks to compete and offer a rate which would ensure customers kept their coins in deposit with the bank. Entrepreneurs who take loans to fund their business would stop borrowing if the rates rose too high, preventing them from having the ability to repay the loan. This was another self-regulating free market mechanism which incentivized competition amongst banks to offer the best rates, to remain profitable.
Another self-regulating free market mechanism of the gold standard was the Price-Specie flow mechanism. This economic phenomenon was first presented by David Hume an 18th-century economist from Scotland. The price-specie flow mechanism is when a country has a positive trade balance, then gold will flow in from neighboring countries until the value of exports is more than the value of imports.
Basically, when a country’s economy becomes too wealthy, it becomes too expensive for neighboring countries to buy goods, but it also becomes advantageous for a wealthy country to buy cheaper imported goods from neighboring countries. This will cause an outflow of gold, from the wealthy economy into the less wealthy economy until it reaches a natural equilibrium and goods are no longer cheaper for the now, not so wealthier country.
In our modern era, central banks can distort this self-regulating free market mechanism by simply printing more currency, and artificially suppressing the price-specie flow mechanism, by creating artificial downward price action. Or they can reduce the money supply and strengthen their currency’s exchange rate.
In our current central bank-managed economy, the money supply is regulated by the central banks. They decide how much new money to print. They also set the reserve requirement and the short-term low-risk rates for inter-bank lending. This rate is the foundation for all the other interest rates set throughout the rest of the economy. When we had a free banking gold standard, the money supply was regulated by mining companies, and how much gold they extracted. If they extract too much, inflation would make mining less profitable, and fewer companies would invest in mining. If they extracted too little, mining would become highly profitable, causing more resources to be invested in more mining operations. It was another natural, free-market equilibrium that kept things in check.
A gold standard, in the purest sense, refers to fractional-reserve banking, under free banking. This means that there would be no regulatory oversight on banks. There is no reserve requirement. They would be free to issue their own gold-backed bank notes, checks, and issue credit as they see fit. The government would only set the price of the currency in gold, and banks would be able to issue fiduciary media at their own discretion.
The market would self-regulate with bankruptcy. There would be no such thing as too big to fail. If you run a bank with an irresponsible monetary policy, bankruptcy would be the consequences. The competition among banks would be the motivation to run a legitimate bank, with an adequate reserve requirement, and sober monetary policy. In a free banking fractional reserve system, it is up to the depositor to research the institution they are doing business with and to make sure they are an honest and reputable organization. It has a lot in common with the current unregulated state of Bitcoin.
Fractional-reserve free banking was a highly unstable system, due to human nature, and the absence of a lender of last resort. When people can just create money, they tend to do it irresponsibly. Fractional-reserve free banking was also more vulnerable to the business cycle. In times of prosperity, banks tended to loan out way more than they should. It is in prosperous times when they should be more conservative with their monetary policy, to prevent recession & inflation. By the time they tighten up policy, it’s usually too late, and recession had already taken hold. They then decide to go into a conservative monetary policy, at the worst time, because they tend to stop lending, even to each other, when loans and easy credit are needed most, in order to stimulate spending and give the floundering economy a much-needed boost.
Early days of banking
Under our current system, depositors are considered unsecured creditors. This means that if the bank goes bust, you’re the last one in line to be compensated for your loss if you’re compensated at all. This is true in the US as well as Europe, where we saw depositors in Cyprus forced to take a haircut on their funds held with the bank. Depositors in our current system are at the mercy of the banks, have no recourse, and are completely disenfranchised. When you put your money in the bank, the ownership of those funds are legally transferred to the bank. You can thank the Dodd-Frank Act of 2010 for the changes in the law which made things this way.
In the early days of banking in the US, banks privately operated and issued their own notes. This era was called the free banking era. Each bank issued its own beautifully engraved notes and at the peak in 1860, there were over 10,000 different bank-notes in circulation. There were copious bank failures and successful counterfeiting acts during this period, which led to the creation of a national currency. In the US, the comptroller of the currency began to oversee banking on a national level. These new national banks bought securities from the government and received national bank notes in exchange. This was central banking, on a gold standard.\
This system was how our economy functioned during the La Belle Époque. La Belle Époque was a period from 1871-1913, which was lauded by Saifedean Ammous as the most prosperous time in human history in his book the Bitcoin Standard. This was due to the sound money offered by a gold-backed currency and national banking system. It worked all the way until the establishment of the Federal Reserve system. With the establishment of the Federal Reserve, we see Keynesian economics take over, and the end of the free market. This is how we arrived at the financial system that we currently have, where central banks control the supply of money, interest rates, and set monetary policy.
The recent economic problems we have had are due to using soft inflationary money instead of hard sound money. This has historically been the cause of great economic recessions and collapses. This is really the underlying cause to the market bubbles we see again and again due to the very relaxed monetary policy created by the central banks. Satoshi was well aware of all of this, and even included a newspaper in the Bitcoin genesis block alluding to this reality. The headline to the newspaper was “Chancellor on Brink of Second Bailout for Banks” about the bailouts handed out to the banks during the 2008 financial crisis.
Now that we have an idea of what banking was like during the era of the gold standard, let’s speculate on what the world might look like on a Bitcoin standard.
Banking With a Bitcoin Standard
What will banking look like under a decentralized cryptocurrency like Bitcoin?
Well, first of all, we would expect to see an explosion of loans and credit denominated in Bitcoin. This is not to say crypto-asset backed loans, denominated in fiat, and collateralized by cryptocurrency. In the scope of this article, that is not a true cryptocurrency-denominated loan, since the value is still being calculated with fiat currency as a unit of account. With increased adoption, we can see price stability increase, as right now cryptocurrency is far too volatile to effectively loan out or borrow.
We can’t just assume that banking will emerge on a Bitcoin Standard in the same way it did with gold. Bitcoin, while it does share some similar qualities, is a new technology and is fundamentally very different than gold. I suspect that we will see radically innovative new approaches to solve the age old problem of managing wealth. Bitcoin’s use case as programmable money makes it wildly more versatile than any other asset or commodity.
One of the most important technological advances we have had for cryptocurrency is multisignature wallet addresses. Multisig is a way to store your coins using multiple private keys, held by 2 or more people. It is much more secure because the coins can’t be moved without coordination of the parties holding the keys. It is based on Pay 2 Script Hash (P2SH) addresses. Multisig will allow for a lot of different trustless services. People can use it for trustless escrow, trustless institutional custody, trustless trading, and a very high-level of security. Multisig eliminates the risk of losing your keys, or a device with your wallet on it, and also greatly minimizes the risk of theft, hacks and $5 wrench attacks.
Multisig is the virtual equivalent of having a safe deposit box at a bank, where they keep a key, and you yourself keep another key. The safe deposit box can’t be opened without both keys, adding an extra layer of security. Multisig will be instrumental in creating trustless and cryptographically secure solutions for many financial products and services currently offered by trusted 3rd party intermediaries. This disintermediation will create cheaper, safer and more convenient non-custodial alternatives to highly centralized and regulated custodial services.
This will also impact the way these kinds of services are designed, from the ground up. Instead of current custodial solutions where you leave your coins with a business for cold storage, in their secure vault, we may see a migration towards services where you hold your own coins yourself, in a multisig wallet with a vetted firm holding the other key. The firm would simply be authorizing your transactions whenever you choose to move or spend your coins. They would not be involved in custody or warehousing of other people’s funds.
This would greatly reduce the onerous regulatory burdens that businesses have to comply with under current custodial solutions. This would also alleviate intrusions on your privacy by regulators requiring AML/KYC and other ineffective methods for combating fraud and crime. Everything could be done with private keys, rather than using personal information, we just need to see people begin to build the infrastructure in this trustless, non-custodial way.
Another important factor for a Bitcoin banking standard is that as a private non-governmental decentralized money, it must defend itself, from back-door control and manipulation. We must resist government fiat currency being defined in terms of Bitcoin. If a government can peg its fiat to the underlying cryptocurrency, or define its fiat in terms of cryptocurrency, it will open it to manipulation. A unit of money which shares the same name as a unit of debt causes problems. People would be using the units of sound money for a store of value, while the medium of exchange would be the unit of debt. They would be indistinguishable from each other in trade. This would mean fiduciary media would be the medium of exchange, and as the supply of debt-based fiduciary media expands, we could still see inflation and other ills caused by unchecked credit expansion.
Bitcoin needs to have a floating free-market exchange rate with fiat currencies. Even if the quantity of Bitcoin is strictly limited to 21 million and never changes, the volume of credit which can be created can be manipulated, controlled, inflated, and distorted, under a peg to fiat or Bitcoin denominated fiat unit. This would let governments and central banks manipulate the money supply through credit expansion. Unbounded credit expansion is still a very real risk, even when the supply of base money is finite. Credit expansion is what sets in motion the boom & bust cycle of the Austrian business cycle theory.
In a permissionless financial system based on cryptocurrency, we can expect to see a lot of entrepreneurial experimentation in the types of banking we see emerge from a free market. We may even see a resurgence of free banking, in some sense. There may be a variety of different banking theories put into real-world practice. We may see the rise of many different styles of banking, some with an extremely conservative monetary policy, and others which are full fractional-reserve banks similar to our banks under the federal reserve system. Some may be full reserve banks, others may focus on security and custodial offerings, and warehousing coins for a fee. Others may be merchant banks offering a variety of commercial services.
The immutable record of transactions which are easily verifiable by all participants may make the instability of free banking disappear. If anyone can see the banks balance sheet on the blockchain, they can see what kind of assets and liabilities, the firm has on the books, and decide whether it is worth the risk to do business with the bank. The truly interesting thing will be to witness what kind of unregulated services emerge from the black market. We may see competing services that are decentralized and self-sustaining like a DAO offering shadow-banking services and simply out-competing the regulated alternatives. Recent arrests in Spain prove that criminals are also thinking along these lines.
What kinds of banks can we expect to see?
- Retail Banks – Retail banks are the banks most people have their checkings and savings accounts at. These banks focus on the general public as customers. Currently, these banks make their revenue by loaning out customer deposits for interest and offer a wide variety of consumer credit products, like home loans, small business loans, money market accounts, and credit cards. We could see these banks pivot to cryptocurrency based system easily. We could see entrepreneurial experimentation with the rates set, the reserve requirements, etc. We could see full reserve retail banks which charge fees, or we could see retail banks which loan out deposits and pay interest to depositors.
- Commercial Banks – Commercial banks, in their current iteration, are banks which focus on businesses as customers. They offer similar services to retail banks, but they offer them to businesses. Businesses often need credit lines, much higher levels of financing, letters of credit and other services, which could be issued and denominated in Bitcoin. These banks could also easily switch to a Bitcoin or cryptocurrency based system.
- Investment Banks – Investment banks focus on business customers who need to transact in the financial markets. Investment banks could help business issue stocks, or raise capital in Bitcoin or another cryptocurrency. Security tokens, asset tokenization, initial public offerings and companies issuing bonds, could all be carried out in Bitcoin.
- Savings & Loan/Mortgage Banks – These banks take deposits from depositors and loan them out to other customers who want to purchase real estate. They typically finance consumer home loans. They were important for making the suburban dream of home ownership a reality for millions of people. We can expect a certain sector of retail banks to focus on facilitating home ownership. These loans could also be just as easily denominated in Bitcoin or cryptocurrency.
- Federal Banks or Public Banks – A great example of this kind of bank is the national banking system before the implementation of the Federal Reserve system or the public bank of North Dakota. These kinds of banks work cooperatively with local banks and credit unions to provide public service over profit. For example, the Bank of North Dakota’s loan portfolio consists of business, agricultural, residential mortgage, and student loans. It doesn’t directly lend money, it facilitates a secondary market and buys up existing loans from the banks and credit unions in the state. This kind of system could work with cryptocurrency and also on a national level.
- Central Banks – Central banks set the monetary policy for a nation state, set interest rates for interbank lending, control the expansion of money supply and credit, and act as the lender of last resort. If we had a central banking system on a Bitcoin standard, many of these roles would be diminished by the Bitcoin network’s set monetary policy. These banks would need to stockpile Bitcoin as they do currently with gold and issue banknotes backed by Bitcoin. They would still be able to create credit at will but would be constrained by the auditability of the blockchain, public confidence in their balance sheet, and the price-specie flow mechanism which could result from international trade imbalances. In other words, they could still exist but would be greatly limited in their ability to control monetary policy and artificially intervene or distort the market, causing the boom and bust cycle of crisis and prosperity. Their most important role would be to act as a lender of last resort, as they do now.
- Credit Unions – Credit unions are not actually banks in the traditional sense of the word. They are non-profit financial cooperatives. They are owned by the customers, as opposed to banks which are owned by investors trying to make a profit. Credit unions usually offer services which are comparable to retail banks or commercial banks, except they are usually locally based and service members of the community they belong to. Credit unions could operate on cryptocurrency with very little recalibration.
- Mutual Banks/Cooperative Banks – Mutual banks are for-profit banks that are owned by the members. They are similar to credit unions in this regard. They offer similar services to retail and commercial banks. Implementing a Bitcoin standard could be done with little to no pain points.
- Merchant Banks – Merchant banks are banks that loan to merchants, in exchange for returns. Merchant banks typically lend to established organizations who make huge returns. They extend credit to businesses who will pay back out of the profits of commerce financed through the loan. Merchant banks will be essential to developing Bitcoin-based industries.
- Private Banks – Private banks are typically owned by an individual or partnership. They usually cater to High Networth Individuals (HNWI), and offer a variety of services catering to wealthy customers. They specialize in wealth management solutions, like tax services, insurance, portfolio management and estate planning and trust services. This could all be done with cryptocurrency as well, and will probably be one of the more important Bitcoin-based banking sectors as a new crypto-wealthy elite class arises.
- Islamic Banks – Since Bitcoin is officially considered Halal, we couldn’t leave out this important sector of global banking. Islamic banks are non-interest banks, due to the Islamic prohibition of riba (usury). Instead of paying interest Islamic banking customers pay a fee to the bank similarly to how customers of a 100% reserve bank would pay a fee for banking and warehousing services. This is a banking sector which cannot be ignored as 1.8 billion people globally are adherents of Islam and can be expected to seek out Islamic banking services.
The Bitcoin Future is Here
In a free market, we would expect to see notes that can be traded or redeemed for Bitcoin, with the proof of reserves cryptographically verifiable on the blockchain. One company, Bitnotes, is already developing physical cryptocurrency notes. They employ multisig so you can rest assured that they are secure. They look pretty cool too, like money from the future. They even have a QR code on them which allows you to quickly verify the funds.
Or the banks may issue a device like Open Dime from Coinkite, which is a mini USB stick which you can store bitcoin on, and then use it as cash in the real world. A single device could be used hundreds of times in commerce before anyone redeems the bitcoin stored on it.
For example, if I had 20 dollars worth of Bitcoin on the open dime, you could verify the funds are there, and I could just give it to you in place of the 20 dollars. You could then spend it on something else later and pass it on to another merchant. This could be done as many times as desired. It is a way to make cryptocurrency transactions offline in a cash-like use case. We may see rappers with open dimes and stacks of bitnotes, instead of stacks of cash someday in the future. Efforts in second-layer scaling may make bitnotes, or open dimes obsolete, if people can directly transact in micropayments, although the tech isn’t mature enough for that, yet.
One of the more controversial aspects of a Bitcoin banking system is fractional-reserve banking. Bitcoin was created by anarcho-capitalists who were deeply influenced by the Austrian School of Economics. That being said, if someone can print money out of thin air, they probably will. This is why we will see fractional reserve banking of cryptocurrency and not just loans denominated in cryptocurrency. Fractional reserve kind of defeats the point of using sound money in the first place, but that won’t stop it from happening. The current cryptocurrency staking trend is a form of fractional reserve banking and inflationary monetary policy with cryptocurrencies.
The major problem with mainstream Bitcoin adoption is that it is designed to be sovereign-grade censorship-resistant. Governments and banks want a fully-regulated, fully-surveilled market that requires permission to use. They want control. They want to be able to freeze your account and deplatform you if you tweet something they don’t like. Bitcoin is the antithesis to this point of view. With Bitcoin, anyone can download the software and start using it. Even criminals, terrorists, and money launderers (oh, my!), which although is not desirable, is still a reality we will have to deal with. There will always be criminals and crime, and it’s just a fact of life. Far more important to us with our anarchist’s perspective is financial freedom for all, which is something we definitely don’t have right now.
We will either see states embrace the technology, or outlaw it. The current effort by the Financial Action Task Force (FATF) is a great example of nation-states trying to exercise this level of control. This will cause a split where governments that allow innovation will become amazingly prosperous, benefitting from the paradigm shift. The nations who outlaw it will suffer tremendously as people use it anyway and they become powerless with no authority to stop it. One thing is sure, governments are also competing amongst themselves, so they will never be able to all agree on one policy and coordinate a ban. Some countries will see the benefits of getting ahead of the adoption curve and they will benefit the most. Even if every country did ban it, they won’t be able to stop it, because they can’t even stop the drug trade, or illicit file sharing on Bittorrent, for that matter. The game theory designed into Bitcoin will make prohibition much more difficult to carry out than regulators realize.
This topic is one of the reasons I initially started learning about Bitcoin. I first found out about it, when one of my friends told me about the silk road. I began reading as much as I could about it and fell down the Austrian economics rabbithole. I was a gold bug before Bitcoin, for many of these same reasons. I was enthralled by the anarcho-capitalist possibilities afforded by this technology.
Watching Bitcoin’s meteoric rise, and success so far, has been pretty amazing, and I can’t wait to see more people start using it when UX becomes easier for non-technical types. I truly think we are witnessing a remarkable phenomenon. From Milton Freidman’s cryptocurrency prediction in the ‘90s, we have been able to watch it play out in real time.
We are witnessing the emergence of a completely new asset class, with amazing potential. Once the traditional finance world begins to “get it”, we may see a new renaissance or new version of La Belle Époque as people create amazing new financial services, products, and opportunities. It will be very interesting to see the majority of people in the world dramatically improve their lives by taking back control of their finances.