On-chain Banking Part 1: An introduction
Welcome to this multi-part series showcasing on-chain banking and its potential to transform the nature of finance globally.
On-chain banking refers to financial assets stored exclusively on a permissionless and trustless blockchain, with technical links to the traditional banking systems. When a users wants to receive money or pay using a wire or debit card, then the on-chain assets is instantly sent to the banking system to be spent. If money is received in a users bank account, it’s instantly moved on-chain and starts earning a yield. This serves as an interim solution toward achieving a purely blockchain-based financial world, as envisioned in the Bitcoin whitepaper.
On-chain banking advocates for storing all assets on the blockchain in a non-custodial wallet, where the user has sole control. In this way, a user can send and receive assets in real-time from anywhere in the world 24/7. When using a debit card, the assets needed for purchase are instantly moved from the blockchain to the banking system, which then processes the payment to the merchant.
In this series I will use the terms asset, money and funds interchangeably. While these are strictly separated in TradFi, on a blockchain, all of them are represented as tokens, behave similarly and can be handled in the same way.
I am the founder of MELD, and my team and I have spent the past three years developing an on-chain banking system. This series aims to share our experiences and discuss its future impact over the coming decade. A fundamental difference between traditional banking (TradFi) and on-chain banking is the permissionless and trustless nature of the network.
A permissionless system allows anyone to use it at any time without restrictions imposed by any single entity, thereby preventing discrimination based on sexism, racism, nationalism, or other prejudices. Everyone has fair and equal access. Examples of a real world permissionless system include public parks or the oceans.
In a trustless system, it can be used without human participation. Trustless does not mean untrustworthy. In a system like this transactions can occur without the need for mutual trust between parties, as the rules are defined mathematically, ensuring they operate as agreed on and intended. A typical example of a trustless system is a vending machine, which dispenses goods based on received payments without human intervention.
A financial system that is globally accessible and trustless, without restrictions, is a blockchain. Where on-chain banking is unique is it connects to trusted and permissioned traditional financial systems (TradFi). In on-chain banking, the primary system is always the blockchain, not TradFi.
The primary reasons for keeping funds on the blockchain are speed and flexibility. Blockchain transactions are swift, typically completing in less than two seconds, contrasted to TradFi transactions that can take days and involve numerous intermediaries, adding cost and complexity. Additionally, blockchain assets can be continuously invested, offering yield and instant liquidity compared to the cumbersome processes in TradFi.
Despite these advantages, practical reasons necessitate the use of TradFi, such as paying bills or receiving salaries through traditional means. On-chain banking recognizes these needs and strives to develop a secure and profitable system that connects blockchains to TradFi services.
The most significant benefit of on-chain banking is its inclusivity; it enables anyone to engage in high finance without the barriers typically faced in TradFi, such as nationality, licenses or capital thresholds. With your funds on-chain, you can do anything you want, become a market maker, earn transaction fees, or secure loans, provide trade assurance or buy a bond, without traditional credit checks and other rule that limit these products to the few.
However, on-chain banking also presents challenges, primarily around user responsibility and regulation. In a permissionless setting, losing cryptographic keys means losing assets, a common issue in the blockchain space. Additionally, the unregulated nature of trustless systems demands cautious engagement from users to avoid potential scams.
In subsequent articles, I will delve deep into these topics, exploring both the advantages and challenges of on-chain banking. Overall, this democratizes financial products, offering unprecedented opportunities to manage wealth and contribute to a more equitable economy, regardless of one’s location or station.
