Banking Explained: Overview, Frameworks, Challenges, and Future
Banking is not the enemy. Its historical development was arguably the bringer of capital to pay for ships that were then used to chart the ‘unknown’. For many, banking provides the peace of mind that their position in society is not solely determined by on-hand possessions, bringing a way to safely store and theoretically grow wealth. However, the advent of novel financial technology is threatening the current status quo, as banks are hardly able to keep up with the latest developments.
Banking is, in effect, just an ancient, dusty custodian protocol, hands shaking as it sorts out yield, capital deployment and custody in an ever larger, faster and more dangerous world, with the traditional banking framework creaking under the strain in face of decentralized finance initiatives.
Are banks done for, then? Not necessarily. Banks that choose to adopt emerging technology, new user flows, and are open to the idea of decentralization and crypto integration will likely survive the great filter. Before predicting the future, we ought to address the rich history and conspiracies of the banking industry.
The dystopian narrative to banking is known. From causing the Great Recession, to bailouts, high fees, and too much control over their clients’ finances, banking has had its ups and downs throughout the years. To many, through avarice, delusion and corruption, banks tore the fruit out of the economy and salted the earth behind so that, for anything to grow, massive social and government effort — through taxes, austerity and policy — had to be deployed.
Yet as we economically climb upwards through the headwinds of pandemic, climate, and geopolitical pressure — you do start to wonder if lessons have truly been learned. The world’s banks, far from their fledgling days as lenders working on stalls in the Mediterranean, are now some of the single most powerful entities in the world. They have to be, they control our monetary system. We need strong banks. Yet absolute power corrupts absolutely, and this is where the common man’s hatred of banking seems to emerge from.
Banking vs Crypto
The idea that money, or to be more rigorous, data value, could be done differently, and that humans could transact freely, fairly, and with total autonomy, as they have always sought to do, is where the seesawing crypto market comes from. Banking has indeed helped this endeavour for over a millenia, but the world has recently learnt that there is a better way. With the embodiment of financial transparency and security now available to anyone, anywhere, adopting blockchain technology is the next logical step for financial institutions worldwide.
Whether that’s in a revolutionary fire or peaceful transition, it’s kind of irrelevant. Blockchain banking makes sense, and the banks know it, and it is certain that banks have been working feverishly behind the scenes to understand and adopt crypto while the smokescreen of crypto-fear was thrown up to stall. Banks are smart. As such, 55% of the top 100 banks have already invested in crypto, a trend that will likely continue.
Crypto and banking then, are going to make natural partners. It’s just important how that transition comes about. It needs to restore safe, secure unilateral non-custodial dominion to individuals and entities, while letting them transact freely in the global Web 3.0 economy and take advantage of the massive migration of financial assets due to move on chain in the next few years. It does not need to be a crypto-garnished repeat paradigm of what has already gone before; and for the smartest and fastest institutions and individuals, it won’t be.
The History Of Banking
The history of banking is, in many senses, the history of money. The more sophisticated the financial system of a society, the more successful — in brute terms — that society often was.
Early writing covers the gamut from the Epic of Gilgamesh and the magic arts of language, love and kinship, to a strongly-worded complaint letter about substandard copper. The first recorded debt was found on a cuneiform tablet, and it indeed represents the earliest known writing anywhere.
In more primitive societies, people were their own bankers. Hobbs declares life as a hunter gather as nasty, brutish and short — and this was in some sense because most of your material value was held on your person; and could be taken from you, as it was probably stored as gold or other precious metals.
In the social ledger that we see in archeological digs, although the writing was payments on account — it wasn’t so much a ‘bank’ in any real sense. The same is true for the Tang Dynasty and their issuance of paper notes. Although the currency was a banking currency, could be easily exchanged, and stopped merchant’s backs from breaking, or their horses from suffering blown knees as a result of hoisting mounds when moving precious metals across the enormous country, merchants used the paper money of the government interchangeably in their own provinces. However, without being commodity backed, inflation ruined most circulations and led to economic issues, and rulers like the Mongol Yuan dynasty were known for not honoring worn notes.
Debt, money, and who owes whom. These are the questions at the heart of social function for all recorded history. Early writing was all about tallying who is owed what in society. How these accountants counted is still something of a mystery, but the ledger they created helped society take account and keep function of all the data-value transfer in their primitive economies. As Niall Ferguson says in Ascent of Money, “Money is not metal, it’s trust inscribed.” It consecrates the relationship between lender and borrower. Ancient Babylonian landowners became powerful through lending.
However, these loans were not pure credit, as would later develop in Northern Italy in the 13th century, but rather advances on stored materials in royal storehouses. They were built on notions of human bondage. David Graeber, esteemed Anthropologist, explores in his tinderbox treatise debt: the first 5000 years, how debt has defined, shaped, shackled, and ultimately corrupted society and reduced human social value to the marks on a ledger.
However, this wasn’t quite ‘banking’ as we know it. Modern banking is, in essence, the creation of effective credit systems and the ability to handle multiple currencies used cross-continent, while serving a broad client base. Although early money lenders (loan sharks, effectively) had simple systems underpinned by violence and targeted consumers, this credit system did not extend further than the loan sharks’ local area and did not have diversity.
The flows of different currency and precious metals sloshing in and out of the Vatican at the start of the 15th century made an ideal crucible for the formation of the first banking system that looks something like our own, by the Medici family.
Whereas primitive banks beforehand were monolithic, and effectively dealt with one large client each, and whose success was predicated on the success of those clients, whether that be a Holy Roman Emperor or Plantagenet warlord, the Medici developed thousands of smaller relationships with the merchants of the Italian Renaissance and achieved the broad depositor base and effective accounting systems to scurry money between them.
Giovanni Medici set up branches of his bank in Geneva, Pisa, London and Avignon, as well as the two main branches of Venice and Rome. These branches helped facilitate cross-continent trade in multiple currencies. It would also allow merchants to take on credit while lengthy transactions (involving delivery of goods across several borders) took time to settle so that they could continue to enact their business.
The broad base of the Medici clientele allowed for their risk to be sufficiently hedged and for their banking dynasty to elevate itself to the status of hereditary power. It was a model copied all across Northern Europe, with the successful banking systems of the English, Dutch and Swedish propelling their national economies and creating new innovations. In Stockholm, the Banco began engaging in lending of its reserve of precious precious metals, and is credited with the creation of fractional reserve banking, whereby lending is performed that exceeds the actual cash or reserves the bank actually holds, and a key evolution in the world of money.
In the English and Dutch case, it led to the formation of two of the most powerful empires of the 17th and 18th Century, as the fiscal power and ability for banks to underwrite foreign expeditions resulted in military expansion right across the globe. In this way, it’s important to acknowledge how banking is intimately tied to the power of the nation state, and how modern banking achieves its aims with this state-underpinned monopoly on violence.
The Bank of England, formed in 1697, was endowed with special privileges, and was closely followed by the formation of the national banks of Japan, Germany and France, with monopolies on the gold supply that gave them their power and primacy. This control wasn’t fully relinquished until 1971, with the abdication of the gold standard, and the death of what Keynes referred to as a ‘barbarous relic’. This abandonment followed by capital and credit being allowed to be created without a hard resource underpinning the currency itself, led to the modern banking system we see today.
Adam Smith, in the Wealth of Nations, states “the judicious operation of banking, by substituting paper in the room of a great part of gold and silver provides a sort of waggon-way through the air.” When looking at the modern crypto economy, this “waggon-way through the air” is more pronounced than ever, with the possibility of cross-border payments, currency substitutions, loans, investments and yield all available at the click of a button. The maturation of cryptographic modern finance to the point where something as absurd yet beautiful as flash loans can exist, has created wagon ways all through the ether (pun intended).
The financial revolution preceded the industrial revolution, and it’s arguable it had a far more important effect on the notional ‘rise of the West’. In the 21st century, banks are entities of extraordinary power, and are closely knit into our everyday lives and the health of our nations. Yet, what exactly do they do?
What Banks Do Today
Bank, and banking services, come in a range of guises. There are two main arms, retail and investment banking.
Investment banks are a different breed. Banks leverage available capital from consumer and business deposits and effectively buy low and sell high, just as you do on your favorite CEX or DEX.
It can be difficult to wrap your head around the fact that by placing your money into a standard savings account, you’re effectively funding people to trade your money for you in return for interest and security, but that is the tenet of thinking at the core of banking.
National governments, of course, legislate heavily and enact severe oversight over the banking sector to ensure that the nation’s wealth is not frittered to the wind, including imposing liquidity requirements, strict trading laws, and other capital and regulatory requirements but, judging by not so distant history, this oversight can sometimes be not forceful enough, and the losing banks filing out the world casino come begging to the taxpayer for re-up, being — as they were — ‘too big to fail’.
This means that the banks have so many assets under management, and so many creditors that rely on it to keep paying for fear of a knock-on liquidity crunch a-la 2008, that it simply must be kept solvent — no matter how many wheelbarrows of money need to be printed. A printing that then devalues the savings of all the taxpayers footing the bill.
Of course, this leads to condemnation of the bankers who created the profits off the money before losing it all, but the more sober view is that investment banking had enormous success at generating wealth, particularly evidenced by the deregulation of Thatcher and Reagan and subsequent boom in the financial service economy that followed. In the U.K, 10% of the nation’s GDP is currently created within one square mile in the City of London.
For many, the fiscal conservative’s Faustian pact with an unshackled, banking sector — aided and abetted by the state — and the resultant turbo-capitalism it creates, is an abrogation of our responsibilities toward each other. For others, they can’t get over how much money it makes. The fact is that a strong, mature banking system with little regulatory oversight may provide the apparatus required to truly grow a modern economy.
Retail banks hold your money and keep it safe. They intersect with payment services to allow facilitation of its deployment either as a currency or as a market instrument in forms of saving products. They offer security for your savings with them as a named guardian. Even the most basic current account will pay some (often infinitesimal) interest, with a rate derived from the national bank and adjusted to ensure profit margins for them. They use this to offer economic centrepiece products like mortgages.
They also use their deposits to make personal loans, credit cards and certificates of deposit. This loaning of money to the customer base using their deposits is how retail banking generates cash flow. As a payments infrastructure, banks have become extremely adept at storing your money and allowing it to be spent anywhere. If you live in a mature Western banking economy, your debit/credit card will allow you to safely access your money just about anywhere in the world and in a currency that you need, but at a hefty cost.
It might read strange to an average Western reader’s eyes, but many people do not have the luxury of a bank account; referred to collectively as ‘the unbanked’. As the modern economic system is one built on banking, this significantly reduces the potential of their capital as an economic asset and furthermore excludes them from much of the shared prosperity of a nation (at least in theory). In Western countries, often these people are homeless with no fixed address, and thus no ability to open an account.
Issues with Modern Banking
There are other reasons people choose to be unbanked. According to this 2017 FDIC survey of the unbanked and underbanked, which reports that 6.5% of American households remain unbanked, they include issues of privacy, trust, security concerns, fees and costs. As well as the very poor or homeless, there are those at the top who have the agency, perhaps in the form of land, and lack of material need or social integration to remain banked, and just use AFS (alternative financial systems).
Many of these, frequently political libertarians, choose to keep the majority of their assets out of the system. This may be due to concern about the above issues, but also as the banking and national systems are so closely intertwined that once in a bank account, the government does have the ultimate authority to prise it open and see what’s inside and — with legal force — seize what’s in it. Just like an exchange is the custodian to your crypto, so is a bank the custodian to your fiat deposits.
On all these aspects, any crypto-advocate would tell you that their concern is legitimate. Bank fees are out of control. They need to be to support the huge bureaucracies required to manage international finance systems. The problem is crypto currently has a bit of a fee-problem itself, but one being reduced in waves of technological advancement, with Proof-of-Stake consensus being only one of many totem-pole advances.
Regarding privacy and trust, cryptographic power-to-the-people ownership of one’s money — and a rejection of the financial status quo, is perhaps the defining ambition of the crypto space. The talk of a Venezuelan revolution buoyed on the back of bitcoin has its roots in this narrative. Others are quick to point out the problems of oligarchic wealth that Bitcoin adoption could lead to.
The ‘extreme libertarians’ that created Bitcoin may have their vision hijacked by these cipher-barons. The increasing interconnectivity between state and bank over the course of the last two hundred years is, for this section of the populace, something to be rebelled against.
KYC and other burdensome requirements contribute to this. KYC was set up so banks didn’t become unwitting (or, perhaps, as in the case of HSBC, witting) accomplices of money laundering and criminal activity. However, since banking requires an identity and an address, the practice combined with the increasing connection between banks and the state means that financial sovereignty is not currently a human right. To most, the thought is horrifying and as crypto literacy increases, unnecessary.
The Unbanked In Developing Countries
Around the world, the picture is different. This report from Findex in 2017 estimates that 1.7 billion of the world’s population are unbanked, and that there are a host of reasons why someone from a developing country may be unbanked, from their gender (a women not allowed to open an account by her husband, for example) to their social class prohibiting them, to a simple lack of available infrastructure — like a bank branch, an effective on-the-ground bureaucracy, or stable political foundation to underpin a national banking system.
Being unbanked means returning to a time where your assets were all on-hand, and the security risks that creates. It means the inability to access credit that could promote personal economic growth by investment, or save you from a temporary tough situation or emergency. For all the ire banks receive, being unbanked in our modern global economy is a nightmare.
Safe from your reliance on ancient social methods, for example the Susu, it thrusts you firmly into the realms of the precariat — where a dark future is only an unlucky moment away. We don’t necessarily need banks, but we do need a banking system. Whereas methods like the Susu can work among micro-units, to build prosperity and security we need safe, collective wealth storage, smooth payment systems, and mature financial markets.
Helping the Unbanked
There is a large clamour about how crypto can help ‘the unbanked’. It brings into question, at the cusp of this new economic paradigm, whether banks are truly the right agents, and whether old bureaucratic systems underpinned by the nation states that back them aren’t too inherently entrenched in old, problematic notions of power.
Less dramatically, and more realistically, the question is what banks need to do to adapt. How can they fully integrate with both the more porous nature of global finance cross-border? And how can they provide instant access to a payment and savings system for new populations? Ideally, all at the click of a button. This, then, is the potential that crypto and decentralized finance can offer.
As we will see later on, Onomy Protocol, with its ability for fast, frictionless international exchange and the possibility to hold any crypto, or any fiat-linked virtual denomination, is a chance for the unbanked — both by choice and by circumstance — to get involved with the burgeoning DeFi ecosystem.
What Are Neobanks?
Banks have already made moves to become digitalised without crypto’s help though. Digital banks are online-only subsidiaries of existing banking entities, while Neobanks are new entities that exist entirely online and are the offering of new fintech companies. Digital banks offer specialised services to global millennials, but when you’re dealing with Transferwise, you’re really just banking with Barclays or J.P.Morgan.
By dealing entirely in electronic payments and having no ties to any one government authority, neobanks can overcome many of the infrastructure problems that deny banking to developing nations. They can adapt to the most convenient regulatory environment available, and as accessed online, can be available to any customer with a smartphone. The neobank industry is new, but is predicted to grow exponentially over the next five years.
However, neobanks still need their anchor to traditional systems that can undercut their model. They still need to store their reserve liquidity in some national framework that may object to their activities (many operate in the UK and or tax-light dependencies). When using the Forex market to provide local currencies, they are still at the mercy of dinosaur institutions relying on expensive cross-border settlement bureaucracy that ramp up the price of their services and increase the friction in their operations.
Crypto isn’t in this story fully yet. Yet as adoption spreads, technology advances and literacy improves, fintech companies will surely use crypto to power their services for the speed, security, accuracy and instant settlement they provide. However, these new neobanks, although offering services that improve upon the traditional banking system, still own your money, and can technically rescind access at any time.
Decentralisation and self-custody of your wealth are the final pieces of an international banking puzzle that promises to lead to explosive global growth in wealth as it is adopted. Blockchain technology, implemented the way Onomy plans to, will create a decentralised reserve bank — a central, open-access financial scaffolding that keeps wealth in the hands of the individuals and institutions that provide it, and allow both to deploy their assets with maximum utility in the Web 3.0 economy.
Onomy Protocol: The Decentralized Reserve Bank
A global decentralized reserve bank will act as the ultimate trustless agent that could allow for the supranational effects of the actions of central banks like the Federal Reserve and the Bank of England to be put in the hands of the global crypto economy and unlatched from the nation states that power them. It would be run by a decentralised organisation that can’t change the systems underpinning the bank at a whim.
Just like Medici bankers that gave out currency across Europe, a global decentralized reserve bank could issue virtual, yet collateralized stablecoins anywhere in the world at any time through a simple web browser. These stablecoins can then be seamlessly used for simple wealth storage, portfolio diversification, debt settlement, Forex trading, payment, remittance, or access to the plethora of DeFi-based yield products that far exceed the general interest rates practiced by traditional institutions.
Decentralized finance is taking off. Yet, at the moment, the blockchains on which it operates are siloed, leading to friction in participation with this new explosion of wealth that has the ability to keep the average user from the action. Onomy plans to provide the ability for retail and institutional users to mint stablecoins to interact with any DeFi protocol on any chain. As a truly international decentralized reserve bank, Onomy integrates cross-chain bridges akin to inter-state commerce agreements that allow simple monetary flows across prominent blockchain economies with lower fees, non-custodial capital management, on/off ramps for fiat, and eventual Denom integration into digital and offline commercial activities.
All of this is designed to be intuitive and inclusive to users anywhere — of course, given the national legislative framework that users must abide by. Access does not have to be restricted to the select few that are crypto-native, and can in turn, be opened to anyone — from traditional institutions to the unbanked population.