Kryptolesson #31

How is Blockchain an alternative to the financial system?

Blockchain's first and still largest use case is that of tokens and cryptocurrency (i.e., any kind of digital asset held securely on the blockchain). Therefore, blockchain technology is in direct competition with traditional banks, as it can be leveraged for offering digital analogous to some traditional banking services. Token users can handle financial actions self-sufficiently on the blockchain without requiring banks as third-party intermediaries. Here, we discuss on why and how the use cases of tokens and cryptocurrencies provides an alternative to today's banking. We finally evaluate how realistic a scenario where banks are entirely displaced by blockchain technology is for the intermediate future.

Let's have a look on how the business model of traditional banks works, and what services these perform for us. Essentially, banks manage the flow of money among parties. More specifically, they offer a secure platform to store and transfer money. For allocating money to the bank, the bank pays an interest fee to the deposit account holder. Similarly, one can rent money from the bank; here, the bank receives interest payments on those loans from borrowers. Next, banks securely execute money transfers from one deposit account to another. The primary cash inflow sources of banks are loan interests as well as the fees they charge their customers (e.g., maintenance fees, overdraft or non-sufficient funds fees, withdrawal fees, …).

How can pure technology, with no single person actively being involved in the procedural activities of the system, provide the same services to users that entire banking enterprises do? Blockchain in its essence is not a bank; in fact, it is nothing but a decentral, shared database. It can store information secure and immutable, as all data is saved on each single computer that is part of its decentral peer-to-peer network. Hence, the blockchain can act as a notary, as it securely guarantees the integrity of all data on it. With that, a safe place to store and transfer data can be generated. Users can securely deposit and transfer data of virtually anything they wish for on blockchain – for example, property of financial means, thus overcoming the double spending problem.

What are the advantages of blockchain technology compared to the traditional financial system? Blockchain requires nothing but computational energy for operating. This results in substantial higher efficiency compared to banks, as these require many other resources such as human capital and office infrastructure. Consequently, blockchain as a medium for money storing and transaction activities typically results in considerably lower fees to be paid by end users. Further, it is not bounded to any national or governmental sovereignty, that is why it offers the basis for a financial system with equal rights and opportunities for anybody who would like to participate. Default and monetary mismanagement considerations are overcome by the fact that smart contracts enable allow for complete trustless interactions, whereas the blockchain serves as the only intermediary. This is of great advantage, especially in areas where financial infrastructure is not established properly or central banks are not independent: in countries like Venezuela or Mozambique, inflation is rampant, banking is only accessible in big cities, with most of the population living in the countryside, and commission fees on money transfers regularly incur in double-digit amounts – not even mentioning those of international remittance.

Now, will blockchain actually replace the current financial banking system? Advocates of the blockchain community would argue so. In fact, a blockchain has all functionalities needed to provide a well-functioning, and in many aspects even better alternative, to today's financial system. However, it is still in its infancy stage and needs to become yet accepted by the mainstream. Also, there is little hope unless cryptocurrencies scalability issues such as low transaction throughput or low energy efficiency are overcome. Although its actual impact on the financial world remains outstanding, we certainly believe that even if the Blockchain might not fully replace the entire banking industry, it will definitely drive it to transform.

Photo by Omid Armin