The Evolution of Money, Part 2

In Part 1, we examined the earliest forms of currency exchange. In doing so, we discovered why barter (exchanging goods or services for other goods or services) is a flawed way to conduct business. Despite its centralizing tendencies, today’s modern financial system has worked well for many billions of people.  Nonetheless, as the previous post concluded, “when the opportunity strikes to change the system for the better…(as with blockchain technology), those who have the will to do so, follow.”

Blockchain As Banking Alternative

Consider how today’s banks keep and track transactions in multiple ledgers. Each transaction record depends upon a trusted individual – the banker – to accurately reflect proper transaction information. As the intermediary, the banker is thus entrusted to reconcile transaction records in case of human error.

If you handle a lot of money and need to count large amounts of money, the best option is to use a money counting machine to ensure that the amount is correct.

While this arrangement carries some merit, it also provides the banker (absent stringent controls) some leeway to edit reality based on his or her discretion. Although that rarely happens, simply having such discretion alone introduces mistrust. After all, embezzlement, corruption, and currency manipulation remain rampant in society.

Blockchain technology promises to remove the need for trust. As distributed ledgers are immutable (which is to say the record has the correct data), no editing changes can be made to a transaction record – ever. Simply put, each transaction transmitted via blockchain is verified (by unrelated parties) as correct and true.  Once such transaction achieves network consensus, the public ledger is updated across the entire blockchain network. The data is then sealed into a block of information that will be forever visible to the whole world. Cryptographic data need not reveal user details or locations- only that the transaction did occur between two parties and the amount sent and received. Users can remain private as long as they use a different address for each transaction.  

Blockchain As Banking Instrument

In general, the banking industry is not typically amenable to transparency. The latter tends to erode the competitive advantage that banks enjoy in an already highly competitive industry. And yet, blockchain technology presents a tempting trade-off: public transparency for quick transaction settlements. To circumvent this trade-off, banks are using permissioned blockchains (private blockchains) to enable confidential transactions. Such blockchains can require users to produce certain credentials in order to operate the blockchain and access particular data. As a result, they are not at risk for transacting with unknown parties.

Unfortunately, moving in this direction will create a siloed financial world for banks, one in which blockchain technology is cut off from future innovation. However, its questionable as to whether the financial world is willing to make such a bargain.

Such a “trustless” system promises a wholesale transformation of financial services.

8 Blockchain Transformations of Financial Services

Don Tapscott, the author of Blockchain Revolution, offers a more detailed description as to how financial services will be transformed. He suggests that the blockchain will alter financial services in the following ways,

  1. Authenticates Identity and Value. The blockchain can verify and cryptographically secure identities.
  2. Facilitates payments, money transfers, purchasing goods. The blockchain can transfer value in very large and very small increments and without an intermediary, making such transfers less expensive and far faster. If you are looking for a money transfer platform, you might want to check this Transferwise review.
  3. Provides a reliable store of value. The blockchain combines a payment mechanism with a reliable and safe store of value, thus making savings and checking accounts obsolete.
  4. Encourages lending. The blockchain allows debt to be issued, traded, and settled on the blockchain. This increases efficiency and improves systemic risk. May very well improve the ability of the unbanked to access loans from peers.
  5. Allows for faster exchanges of value. The blockchain greatly speeds up settlement times on transactions. Creates greater opportunities for unbanked/underbanked to create wealth.
  6. Introduces innovative company/asset funding. The blockchain allows for “new models of peer-to-peer financial, recording of corporate actions as dividends paid automatically through smart contracts.” Likewise, as Tapscott notes, a titles registry could automate claims to rental income.  
  7. Improves risk assessment. “Using reputational systems, insurers will better estimate actuarial risk, creating decentralized markets for insurance. More transparent derivatives.”
  8. More transparent financial reporting. “Distributed ledger will make audit and financial reporting real-time, responsive, and transparent, dramatically improving the capacity of regulators to scrutinize actions within a corporation.” This helps you when you are bouncing back from financial loss with a short term loans to understand the market.

— Blockchain Revolution, p 64

While banking critics tend to welcome such improvements, others intend to fully disrupt the banking system altogether. They believe that the banking profession simply facilitates the centralizing of capital in society. And indeed, consumers may choose to bypass banks altogether in the future. How are bankers responding to this existential challenge? Surprisingly well, actually.  As Carolyn Wilkins, deputy governor at the Bank of Canada has noted

“We are confident in our paradigm right now, but we understand many paadigms have a shelf life: they’re going to work well for a number of years and then things are going to start to go wrong. You can fix it at the margin first, but eventually, you just need to switch to something else. Its hard not to be fascinated by something so transformative. [Blockchain] technology is being used in ways that have implications for central banking that span all the functions that we have.” (Blockchain Revolution, p.294).

Whether the banking profession accepts this new paradigm or limits itself to permissioned blockchains remains to be seen. If the industry chooses to fully accommodate blockchain technology, it will likely need to reinvent itself. Given such a large-scale disruption, we may well see the banking profession move toward a more supportive and/or educational role with regard to personal finances. Time will tell.

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