The Problems with Centralized Finance
Our current financial system is highly centralized and quite complex – central banks such as the Federal Reserve issue and control the money supply, borrowing and lending is conducted through the banking system, trading is done through exchanges and the system is supported by a host of national and international regulatory bodies.
Overview of the financial system in the United States Note: No need to analyze this – the entire point is that it’s very complex…
Unlike many in the crypto space I don’t hate banks or international financial systems. In fact, I think that our current system has served us remarkably well and has undoubtedly been a key driver of the prosperity we’ve seen over the last century. It facilitates growth via trade and the international flow of investment capital, provides security and helps establish trust through regulation, legal frameworks and the certification of formal and informal economic actors.
But, like any centralized system, our current infrastructure has become bloated, byzantine and draconian. This leads to numerous problems for the consumer including:
Third-Party Custody: In the current financial system, you don’t really hold your funds – the banks do. This means that they can freeze and even seize your assets at will (while this may seem far-fetched, consider that in 2013, the Government of Cyprus seized 47.5% of all bank accounts over €100,000 to bail-out its failing banking system)
Limited Access: Banks can decide whether they want you as a customer. While generally not a problem in the developed world, this is a huge issue in growing economies. Today, nearly 1.7 billion people remain unbanked simply because they aren’t profitable enough to be considered by global financial institutions
No Privacy: Banks must collect detailed personal information to adhere to KYC, AML and CFT regulations and require credit scores for borrowing
Expensive and Inefficient: The current financial system is rife with inefficiencies and unnecessary expenses. Payment networks charge up to 3% on credit card fees, cross-border remittance payments can take up to a week and cost 10%, and even in developed nations, users are faced with long transfer times and bloated fees.
Lack of Interoperability: Most banks currently operate as “walled gardens”, making it difficult to even transfer funds between entities let alone share and collaborate on new technologies and products.
Opacity: The financial crisis of 2008 made it abundantly clear that our current financial system lacks transparency, as even the droves of regulatory bodies had little idea what was sitting on the balance sheets of our largest institutions
Together, these concerns represent a major problem. Not only do they limit growth, but they also continue to drive inequality.
So why do we tolerate these inefficiencies? Well, we don’t really have a choice due to what is known as the Byzantine General’s Problem. While I’m oversimplifying a bit, this concept basically states that large groups of humans can’t trust one another or coordinate across vast distances without using third parties (such as banks) to establish trust. For example, when a stranger sends you money online, you must rely on your bank to ensure that 1) they are whom they say they are and 2) they have the money they say they have and 3) they actually send it.
In short, while some may call the banking system “evil”, up until now it has been a “necessary evil”.
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