How we get to a semi-decentralised financial system (Part 1)

Not quite convinced on cryptocurrency yet? I can’t blame you. Six years after Ethereum’s fateful DAO hack, cryptocurrency is still seemingly living up to its troublesome reputation. As of this week, another major hack happened on the BeanStalk Network resulting in the theft of $182m in crypto-assets. Its knock-on effects now offering more fuel to the fire behind the EU’s intention to impose stricter KYC measures on both sender & receiver involved in cryptocurrency transactions.

?

Whilst more regulatory oversight in general will likely have tangible positive effects on consumers (in terms of consumer protections), it directly contradicts Web3’s counter-culture for decentralisation and freedom for innovation. Cryptocurrency’s original vision set out by Satoshi Nakomoto in Bitcoin’s white paper in 2009 was for the disestablishment and replacement of large controlling organisations using blockchain technology. In effect, people can be in control of their own money (without banks or intermediaries) …but with that, of course, comes some pretty major custodial problems and teething issues:

?

• Are we ready to look after our own money?
• Do we even want to look after our own money?

?

Since 11th century China, the concept of state-governed money has been a globalised norm with banks housing our money since 15th century Italy. Being in charge of the keys to our own kingdom is certainly not something we have ever been used to.

?

Governments & banks pulling the global financial levers have been an accepted norm for over 500 years, it’s hard to imagine a fully- or even semi-decentralised financial system. Our whole understanding of economics & monetary policy has been written purely around the basis of centralised control; economics as a social science is merely reactionary to the financial world we build. But think back to major global adversities like the Financial Crisis in 2008 or even the levers being pulled by the world largest financial system, the US. The US immediately responded to Covid-19 by printing 20% of all US dollars in existence, experienced record high levels of unemployment in 2021 and is now being hit by 40-year highs in inflation at 8.5%. US citizens are effectively burning 8.5% of their money’s value just by leaving it in their bank account. It suddenly feels pretty natural to hold a level of scepticism over whether financial systems could be better managed or simply supported.?

Whilst a purely decentralised system in the next 30 years might be wishful thinking, a world in which there are both centralised and decentralised financial systems is a very realistic and exciting possibility. A world where it is widely accepted to have both fiat currency held in your (domestic) bank, and digital money in a decentralised, universal wallet.

Why is this revolutionary? Suddenly anyone with a mobile phone and internet connection now has access to a global decentralised financial system, where you can send money or digital assets to anyone anywhere, quickly, and at close to zero cost (e.g. Bitcoin Lightning Network). If you feel your government and its currency is being mismanaged, you can find sanctuary relying on a global decentralised currency instead. The 1bn unbanked people worldwide, for example, could now keep their money safe in a virtual bank – away from corrupted governments and protected from major negative effects e.g. hyperinflation.

?

Of course, cryptocurrency, despite being decentralised, is currently no safe haven if you’re looking for value stability. Crypto prices are very volatile. However, stability will naturally form over time with its mass adoption. Until then, there are some strong immediate use cases for stablecoins (e.g. USDT, USDC, UST) which could have some highly impactful effects for many people needing to protect the value of their assets whilst reaping the benefits of being a part of a politically- or economically-neutral global financial system.

?

So what could get in the way of cryptocurrency reaching mass adoption? A lot of things. A blanket of global regulation could hugely slow or impede technological advancement. Perhaps we find that only stablecoins provide value and cryptocurrencies were just the petri-dish. Perhaps Ethereum won’t scale despite being the most vibrant and active crypto-economy today, and might take an additional decade or so for another blockchain to take its place (See “Ethereum killers” such as: Avalanche, Solana, Luna). However, there is one thing I truly believe that will either make or break cryptocurrency and its further adoption. And that is its Security.

?

In my opinion, there is a thorn in the side of this semi-decentralised paradigm. That being, a lack of security. Why is this problematic? Because blockchain’s promise to the world is security - being an incorruptible and trustless way to manage ledgers of data (in effect, for the financial world, being able to replace a bank or bank account).

?

What is the lack of security causing? Distrust. Distrust of cryptocurrency remains due to its unfortunate and continued reputation for hacks, scam and hype. The technology could revolutionise our financial systems and many other industries including law, supply chain and healthcare, but this can not happen without security. Consistent smart contract vulnerabilities, node backdoors or weak crypto governance (even with multi-signature protections) consistently being taken advantage of, and making multimillion dollar hacks a normalised occurrence. Money does not yet feel safe in this exciting but nascent industry.?

In the last 12 months alone, we have seen some of the largest hacks in crypto history taking place…we can now add the BeanStalk Network hack to the list:

• $540m - Ronin Bridge, March 2022
• $325m - Wormhole, February 2022
• $611m - Poly Network, August 2021
• $532m - Coincheck, January 2018
• $470m - Mt Gox, February 2014

?

Financial systems are built to provide security. Not just in providing the custody of our money e.g. bank accounts, but providing security in our money’s value, and security in our money’s ability for buying goods and services. Security, security, security is crucial for a trusted financial system.

So let’s discuss what needs to be done to bring security and trust into a decentralised world…