Ideal Banking

Ideal Banking

The Blockchain Revolution: Transforming the Banking Industry

Introduction

The world of finance has undergone significant transformations throughout history, with money evolving as a technological tool in response to the need for efficient trade. While financial services have adapted to an ever-changing market, the underlying principles of supply and demand remain. However, this traditional banking system is not without flaws. It relies on trusted third parties, such as central banks and commercial banks, creating a system that is prone to breaches of trust, credit bubbles, and privacy concerns.

The rise of blockchain technology presents an opportunity to address these issues and revolutionize the banking industry. This article delves into the intricate workings of the current banking system, highlights the limitations and risks involved, and explores how blockchain can provide a more efficient and secure alternative.

Tracing The Circuit

To understand the shortcomings of the current banking system, it is crucial to examine the flow of money within it. At the heart of the U.S. banking system lies the Federal Reserve and the Treasury, which control interest rates and the issuance of U.S. Treasuries, respectively. The U.S. dollar, which is considered the reserve asset, is in fact backed by U.S. Treasuries rather than the currency itself.

Traditionally, the Treasury issues debt in the form of U.S. Treasury bonds, known as USTs, which are sold to private banks. These banks then create credit by generating dollars in customer accounts to finance the government’s budget and service its debt. The issuance of new debt to service old debt may seem illogical, but it becomes more understandable when one considers that not all debt is created equal. The percentage of profit generated as yield and the duration until bond maturity are the defining factors of debt. Longer durations (e.g., twenty years) result in higher yields (e.g., 2.4%), reflecting the higher risks associated with longer-term investments.

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The U.S. government regulates debt supply by influencing the short-term interest rates on offer for short-term Treasury bills, also known as T-bills. When the government wants to sell more debt, it increases the yield on T-bills, attracting capital seeking profit. Conversely, when rates fall, personal debt becomes more attractive due to reduced borrowing costs. This credit-debt cycle is susceptible to volatility, and banks, in their role as lenders, are left vulnerable when depositors withdraw funds. In such cases, banks must sell their assets, potentially incurring losses.

The New Dollar: FedNow, Not Retail CBDCs

While the dollar has been digitalized to a certain extent, with retail accounts and services like Zelle and Venmo, the mechanisms behind the transfer of U.S. Treasuries and reserve assets have remained outdated. However, the upcoming launch of FedNow aims to provide the Federal Reserve with more efficient control over overnight banking rates, such as SOFR, which determines the cost of borrowing short-term liquidity between banks.

The repo market, where short-term loans are collateralized by assets like USTs, plays a vital role in maintaining liquidity in the banking system. FedNow creates a digital mechanism for the Federal Reserve to control this market by regulating interest rates and managing the transferring of Treasuries among banks. This digital lever ensures centralized control and aims to reshore dollar-denominated activity from offshore markets back to the United States.

Banking Is More Than Payments

Contrary to popular belief, banking encompasses more than just payments. While Bitcoin has demonstrated its potential to replace USTs as a world reserve asset and an interbank settlement network, it needs additional tooling to replicate the full functionality of a banking system. Bitcoin, unlike traditional banking systems, utilizes a UTXO (unspent transaction output) model, where transaction outputs are aggregated to form wallet balances.

Layer 2 solutions, such as the Lightning Network, enable near-instant and trust-minimized settlements, resembling the functions of credit and debt within the Bitcoin network. These Layer 2 solutions simulate traditional financial services and facilitate trustless yield generation through routing fees. However, they also come with privacy challenges, as they operate on an open network and ledger.

Enter ecash

To address these privacy concerns, David Chaum introduced Chaumian mints in the 1980s. Chaumian mints leverage blind signatures to provide near-perfect privacy within a federation. Ecash, the digital currency issued by these mints, adopts a token mechanic similar to bitcoin. Ecash wallets hold multiple iterations of common denominations, ensuring greater fungibility and anonymity. While transacting within Chaumian mints guarantees privacy, external settlements can potentially be traced through careful metadata collection and poor security practices.

Chaumian mints, such as Cashu and Fedimint, diverge based on their federation structures and the denominations of ecash they issue. Cashu, a single-signature instance, allows for fast and easy operation with Lightning Network integration. In contrast, Fedimint implements multisignature capabilities, distributing mint duties among trusted parties. Both instances rely on blind signatures for validation. However, validating reserves against liabilities remains a challenge, as the privacy-preserving nature of ecash limits transparency.

The New Mint

The construction of Chaumian mints involves decisions regarding the federation structure and the denominations issued. A federation can consist of a single signature with administrative access or multiple trusted participants in a multisignature arrangement. Ecash tokens, issued in common denominations, act as digital bearer assets, ensuring greater fungibility and anonymity within the mint. Proof-of-liability schemes, although complex, can mitigate risks related to reserve asset custody.

Minting Your Own Bank

Blockchain technology and its implementation through Chaumian mints present an opportunity for individuals and communities to become their own banks. By decentralizing the issuance of money away from central authorities, bitcoin emerges as the ideal reserve asset. Although the base layer of Bitcoin cannot serve the entire global population, layer 2 solutions, equipped with ecash, bridge the gap by combining the benefits of privacy, scalability, and stability.

The future of banking lies in the proliferation of ecash instances, tailored to the specific needs of online communities, mining pools, and financial service providers. These instances, backed by bitcoin, offer greater autonomy, privacy, and efficiency compared to the current banking system. As the cracks in the traditional U.S. banking system become evident, the ecash revolution gains momentum, heralding a new era of financial sovereignty and independence.

Conclusion

The blockchain industry has the potential to transform the banking sector by addressing the flaws and limitations of the existing system. By leveraging the transparency and security of blockchain technology, the new era of banking can minimize reliance on trusted third parties, ensure privacy, and offer greater control and autonomy to individuals and communities. Through ecash and the pioneering work of Chaumian mints, the possibilities for a decentralized and efficient banking system are endless. As the world embraces this technology, we stand on the precipice of a financial revolution that will reshape the way we perceive and interact with money.

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