can cryptocurrency replace banks?

June 02, 20184 min read

A long time ago, when we lived in small tribes, everyone was expected to contribute to the group and ‘pull their own weight’. It was easy for us to enforce this norm, because our tribe was small enough that everyone would notice if you were lazy or selfish. And if you took more than you gave, you might be ostracized or exiled.

In larger societies, we can no longer keep track of the giving and the taking. Instead we abstract ‘givingness’ and ‘takingness’ into money. Instead of sharing excess vegetables with the tribe in exchange for good will, you sell excess vegetables to the tribe in exchange for market power.

The invention of money lead to the creation of a new institution: banks.

Banks serve two main purposes:

  1. We don’t feel safe walking around with thousands of dollars in cash, so we keep our money secure in a bank.
  2. Now that our society is too big for us to individually keep track of who owes what, we outsource tracking to the bank. Banks, in essence, are institutions that we trust to keep track of value exchanged. In fact, banks hold very little analog cash… Instead, they simply keep records of how much ‘cash’ we have accumulated, and display it on a screen.

#2 used to be mega-important; Without computers, we had no other option.

In 1950…it was customary for banks to close their doors at 2:00 P.M. every day so that armies of bookkeepers could manually process and update the day’s accounts

- Markoff

But there’s a problem: we can’t always trust banks. Not when they create fake accounts on behalf of customers (ahem, Wells Fargo), or require taxpayer bailouts of $700 billion.

Future Societies

Cryptocurrency can perform both of the bank’s most important functions.
(1) Rather than the bank securing our money, we keep our money secure in our crypto wallets.
(2) Rather than the bank keeping track of who owes what, we outsource the task to a decentralized public ledger.

Crypto has the potential to offer the benefits of the banks without the drawbacks.

Unfortunately, crypto has one major issue: you access your money using a private key. What if you forget your key? Or what if you write your key down (to prevent yourself from forgetting it), and someone finds it and steals all your money?

By taking value-tracking into our own hands, we are spared from being defrauded or ripped off by a bank, but we leave ourselves open to another vulnerability: ourselves, our poor memories, our general carelessness.

Banks provide multiple safeguards against loss and theft. Usually you are identified by possession of a credit card, as well as by signing a receipt in a way that vaguely matches all your previous signatures (the original two-factor authentication 😉).

However, if you lose your credit card you can report it to the bank, and they will verify your identify another way, such as asking for your social security number. Even in the case of identity theft, there are remedies built into our banks and government.

With crypto, there is no backup. If you lose your private key, you have no recourse.

I now think of banks more like insurance: a way to pool risk. The bank can put a lot more money towards security than an individual can. And if someoneisable to steal money, the bank will usually cover it for the customers. And if the banks steal money, (for example, through fraud), the government will bail them out. So banks are essentially institutions that spread the risk from bad actors among everyone, rather than leaving an individual vulnerable to theft.

I suspect that cryptocurrency will replace banks, but the cryptocurrency ecosystem will start to look a lot more like banks. We’ll need more safeguards in addition to private written keys, like a biometric crypto key and protection and recourse against hacks.