According to Morgan Creek Capital’s CEO, Mark Yusko, “A bankless society is inevitable due to the evolution of technology.” Over the past couple of decades, it’s undeniable how much the financial industry has changed. People have shifted from simply using paper money and ATMs to digital payments and online and digital services.
However, all these financial services have depended on banks as the main coordinator and facilitators. But, with the inception of the first cryptocurrency, bitcoin, in 2008, this ecosystem began shifting to a more open and distributed financial model that lets people become their own banks. Does this mean that we will live in a bankless society and banks will completely disappear? Will distributed ledger technologies replace traditional financial services? In this article, we will take a deep dive into what it means to be a bankless society and some of the tools that facilitate such an ecosystem.
Blockchain: The backbone of a bankless society
Before we consider what the ecosystem of a bankless society might look like, let’s first recap on the technology behind the bankless revolution — blockchain technology.
According to IBM, blockchain can be defined as a shared, immutable ledger that facilitates the process of recording and facilitating transactions and tracking assets in the business network. Within the blockchain space, an asset refers to anything tangible like a house, cash, car or intangible like intellectual property or patents.
Blockchain is revolutionizing traditional financial institutions through decentralized finance (DeFi), a multi-million dollar ecosystem serving intermingled concepts in the blockchain and finance sector. In simple terms, DeFi is a collective term for financial services that do not rely on intermediaries or third parties. Blockchain facilitates all transactions.
The most established DeFi platform is Ethereum, with a total volume locked of $108.51 billion, 54.59% of all the value in the DeFi space, as of March 14, 2022. Ethereum was the first major blockchain protocol to move beyond a simple currency replacement, such as bitcoin, to more automated financial solutions through smart contracts. What is pivotal with DeFi is that developers can establish complex financial ecosystems that run on code rules, thus eliminating third parties like banks or brokerage firms.
How does this work, and what are the tools for a bankless society?
DeFi, through Blockchain, provides for untrusted parties to agree on the state of a transaction without the need for middlemen. By leveraging Blockchain’s ledger technology, DeFi can onboard financial services like payments or securitization but without the need for banks. Further, DeFi allows the use of various tools proving to be key factors in the shift to a bankless society. Some of these tools include:
1. Digital currencies and Financial regulations
At its core, DeFi relies on digital currencies like bitcoin (BTC) and ripple (XRP) to facilitate transactions globally. However, unlike traditional fiat currencies or digital cash in your bank accounts or payment apps like Apple Pay, cryptocurrencies are not governed by banks. Cryptocurrencies are developed on top of blockchain protocols, which govern them completely. This means the supply, production or even reduction of a cryptocurrency is completely hardwired into the code.
This operates quite differently from the traditional banking system. For instance, in the United States, the Federal Reserve (FED) is in charge of conducting national monetary policy by influencing monetary and credit conditions and changing inflation rates by amending interest rates. Additionally, the FED is responsible for supervising and regulating banking institutions to ensure the safety of U.S. banking and maintain financial stability.
In a DeFi ecosystem, smart contracts automate all these functions. Bitcoin, for example, is hardcoded to have a maximum supply of 21 million bitcoins. When it comes to supply, the Bitcoin protocol releases BTC to the cryptocurrency economy as block rewards to miners — those in charge of validating transactions and adding them to the blockchain. This is done so sequentially. Currently, miners receive 6.25 BTC for every successfully mined block. Moreover, this supply is halved after every 210,000 blocks or roughly four years, limiting BTC supply as demand rises.
In such an ecosystem, printing more money, inflation rates, and currency supply are delegated to the blockchain protocol instead of banks. With the mainstream adoption of cryptocurrency, which Mark Yusko believes is inevitable, we could see a crypto-based financial ecosystem that is self-sustaining and governing.
2. Peer-to-peer payments without third parties
Today, the conventional banking sector is established on top of slow payment systems with added fees at almost every authorization level. Facilitating payments and imposing fees is highly profitable for banks, providing them with little to no incentive to lower the fees.
On the other hand, cryptocurrency protocols like Bitcoin and Litecoin are designed so that users can send and receive funds directly. Public blockchains eliminate the need for intermediaries or trusted third parties to verify transactions. As such, they provide access to cheap and borderless payments.
Cryptocurrency transactions also rely on digital wallets like Metamask, Trust Wallet or Coinbase. Generally, digital wallets are like your typical wallet, but they store funds online. Moreover, instead of having a bank account number and a pin, you are issued with a wallet address that, in most instances, cannot be traced back to your data. Sending funds using digital wallets simply requires the recipient’s wallet address and a passphrase that acts as a pin. Enter the amount, send it, and the protocol will deposit the funds in their account in near real-time.
Another key factor that cryptocurrencies play in a bankless society is providing faster payments. Bitcoin, the largest cryptocurrency by market cap, has an average transaction speed of about 10 minutes, although this can change depending on network activity. However, this is faster than traditional banks, which can take up to 3 working days. Despite its speed, bitcoin has an added layer of solutions (layer 2), known as the lightning network, which aims to achieve a transaction speed of less than a minute, if not a millisecond.
Moreover, according to JumpStart, other blockchain protocols, like Solana and Fantom, can achieve up to 50,000 and 25,000 transactions per second. These protocols also offer these high-speed transactions at very low fees ranging from $0.0001 to $0.00025. Banks might become less favourable to most people in such a system as cryptocurrencies offer faster direct P2P, near real-time and cheaper transactions.
3. Loans and credits not issued by banking institutions
Conventional banks and lenders underwrite loans based on a system of credit reporting. They check your credit score, home-ownership status, debt-to-income ratio and the assets you own. Banks have to go through your entire financial status and personal data to get all this information. Based on this data, they then calculate the risks involved, the interest rates, the fees and the collateral in case you default on your loan.
Blockchain technology opens up the possibility for P2P loans. Unlike banks, blockchain implements smart contracts with complex loan protocols, loan structures, and a faster and more secure loan process. With P2P loans, users can borrow directly from other users or a pool of funds. This means they eliminate any third party banks and receive cheaper, faster and more secure ways to acquire loans from a large pool of customers. Blockchain also provides users who hold their crypto assets a way to earn interest by offering them a loan or participating in a loan pool.
One key factor to note with a bankless society using blockchain is that the protocols always over collateralize cryptocurrency loans. However, since banks offer over-collateralized loans, blockchain-based loans should not deter you.
For instance, if you are a long-term investor of a crypto asset like ether, you want a bankless loan and to still hold your assets. You might choose to participate in a loan pool by depositing the ether. This way, you can take out a partial loan and earn interest from it. If ether’s price goes up, you can leverage this opportunity and pay out the loan, thus retaining the loan you took out and still having your assets earning interest.
Excellent examples of projects that are shifting the loans and credit services to a bankless system are Maker, Aave, Curve Finance, and Compound, to mention a few. You can review DeFi Pulse to view a complete list of the best project for your bankless journey.
4. Clearance and settlement systems that do not depend on banks
As mentioned above, bank transfers often take up to 3 days to be finalized. This is large because of the underlying framework of the banking ecosystem. Today, a simple transfer from one bank account to another has to pass through various complex intermediaries from correspondent banks. The simple transaction has to be reconciled across global financial systems since most banks do not have a direct relationship with one another.
Moreover, SWIFT protocols do not make this process any faster because they send out payment orders to the banks involved in transactions. Intermediaries handle the actual payment, adding to the cost and potential failure.
Blockchain technology, which serves as a distributed ledger, can provide a global ledger that can act as an interbank protocol. Instead of relying on global bank settlements, blockchain-based financial institutions can leverage the ledger. Further, a blockchain ledger can offer large-scale settlements to process transactions in real-time.
An excellent example is Ripple, an enterprise blockchain service provider. It aims at building a blockchain-based solution for conventional banks to clear and settle transactions using IOUs and the XRP cryptocurrency.
5. Securities and Non-fungible tokens
To keep track of assets like stocks, debt, securities and commodities, conventional systems force investors to use a complex chain of brokers, exchanges, central security deposits, and custodian banks. Most of these entities have been built on traditional transactions requiring paperwork to prove an asset’s ownership. Since most investors do not want to handle all these certificates, paperwork, bookkeeping or asset management, they prefer to buy assets electronically. Most of these underlying platforms outsource the certificate to the banks or other third parties for safekeeping.
Furthermore, this issue also applies to the real estate sector. Most investors rely on banks to keep their title deeds and ownership certificates safe. This process also involves government institutions that further delay the process.
DeFi aims to shift all these to a bankless ecosystem that relies on a distributed database. One key feature of a blockchain ledger is that it is immutable and consistent. This means that each node on the network has the same ledger copy. Because of this, blockchain makes it easy to transfer ownership rights from one party to another in the form of cryptographic tokens of assets. All that is required is for the ledger to be updated with the new state of the transaction.
Ethereum and Blockchain have accomplished transferring digital currencies in cryptographic tokens. However, other companies are working on better ways to represent other real word assets. For instance, the recent NFT craze during the last half of 2021 has shown that they are an effective way to represent digital art.
Further, through smart contracts, tokenized securities can work as programmable equity when:
- Paying out dividends,
- Representing fractions of real estate ownership, or
- Representing company shares through Security Token Offerings — a security token that is regulated by the SEC and offers tokenized IPO as a type of public offering of digital securities sold in a security token exchange,
Blockchain achieves these through automated code hard-coded in smart contracts.
The future of a bankless society
The last few decades can attest to the disruption technology can have on the financial sector. We have witnessed a financial shift from paper currency to electronic payment. With the addition of blockchain technology, the banking sector might embrace it. However, this is not to say that cryptocurrencies will completely replace banks, but they rely on blockchain architecture to facilitate nearly all transactions.
While blockchain and cryptocurrencies are still in their infancy, and the network has not tested many of their applications, the notion of a bankless society is not out of the picture. Through fast and cheap P2P transactions, easily available loans and credits and faster clearance and settlement systems, blockchain will indeed transform the banking industry.