TL;DR:

• Post explores some of the pain points I’ve observed as I've searched for a sustainable way to do more on chain
• If the Web3 community can focus on developing practical use cases to enable basic financial settlement on chain and / or significantly reduce on-ramp and off-ramp fees, retail users will get comfortable migrating on chain
• I think focus on (i) driving adoption of seamless and fee light direct deposit on chain of income earned off chain and (ii) settlement of high dollar low volume payments on chain will entice Web3 curious users to explore the ecosystem more seriously and will lead to increased exploration of other protocols (NFTs, Metaverse, DeFi, DAOs, etc.).

These are my opinions. What are the products / services / features that you MUST have to migrate away from TradFi and into the Web3 ecosystem? Feel free to reply to the companion TWEET to this Mirror post. #Learning.

My previous post comparing a number of financial system features that are important to me as a retail user is also relevant to the content in this post.

Core set of tools to enable much of what TradFi retail banks do to pull new users on chain

I would like to identify, evangelize, and ideally help build (if the components pieces don’t already exist) a Minimum Viable Bank on Chain (“MVBoC”) collection of dApps. I’ll approach these selfishly for my own desired use cases, but I also think this MVBoC will be broadly applicable and help to drive adoption of Web3. My MVBoC will be different than other users, but hopefully covers enough surface area to get prospective users exploring the ecosystem more productively.

Reasonable fiat on-ramp

Depending on the Centralized Exchange (“CEX”) used, transaction fees and spread fees can cost anywhere from 0.4%-2.0%+. There is an additional fee to transfer tokens to a self custody wallet. Most CEXs currently only transfer to ETH mainnet (within the Ethereum ecosystem), so if you prefer to operate on L2s (Optimism, Arbitrum, etc.) there are additional bridging fees. These fees add up quickly and are quite steep when compared to my typical monthly fees of $0.00 or 0% in TradFi.

If I plan to bring assets on chain and make monthly payments for goods or services while still receiving some yield, I need to cover that 2.0% fee with offsetting yield just to break even, which implies I can find a dApp or DeFi protocol with an APY of 27.3% and assumes I don’t have to off-ramp the assets. This level of yield is not easy to find, especially with low risk.

Alternatively, I could break even (fees paid vs yield earned) if I earn yield at a lower rate over multiple months on savings or surplus assets, but I don’t think that is an assumption that should be made given many prospective global users don’t have savings sitting idle and would therefore be excluded from using the network economically.

Direct deposit options

My current employer does not enable direct deposit into crypto, so I have not been able to experiment with this option. I know some options do exist (e.g., OnJuno), but until I can actually test and follow the cash to see all of the fees I’ll abstain from speaking to the economics. I suspect that there is a fee structure similar to the CEX fiat on-ramp for using these services to swap from fiat based paycheck into Cryptocurrencies.

Ideally, employers would start to adopt $USDC / $DAI / $BTC / $ETH, etc., and pay compensation directly in these tokens so fiat conversion and transfer fees can be avoided altogether.

Yield on assets

Lets briefly set aside fees and focus on yield. It appears we’re about to exit a 20-30 year period of abnormally low interest rates and time will tell what the impact is to retail user account interest rate yield. I suspect that since retail users are well conditioned to receive near zero yield on their deposits and TradFi has a lot of power over retail users (i.e., access to a financial system is useful and switching TradFi banks is a pain), I don’t expect to see meaningful increases to retail user account interest rates even as market rates rise. Incumbent TradFi banks may compete based on retail account interest rates, but I’m suspicious retail will noticeably benefit (benefits likely will go to preferred customers, e.g., high net worth individuals, corporations, financial institutions, etc.).

However, the compounding effect of interest over any extended period of time is powerful. To illustrate an extreme case, the following chart displays 30 year growth of $1,000 USD (but could be applied to 1,000 of any units).

In practice, users will likely redeploy at least some amount of interest earned for other purposes, but the chart above helps to frame the magnitude of value capture that is in play.

The principle bar is constant at $1,000 throughout. The TradFi interest bar compounds to a total of $251 or 25% (at 0.75% APY, my current savings account interest rate) over 30 years. Pre merge incremental compounds to a total of $2,494 or 249% (at 3.75% APY, 4.5% APY excluding 0.75% APY from TradFi) over 30 years. Post merge incremental compounds to a total of $9,521 or 952% (at 4.5% APY, 9.0% APY excluding 3.75% APY on pre merge incremental and 0.75% APY from TradFi) over 30 years.

I will break this down in more detail in a future post and the pre and post merge vernacular could be substituted for any sources of stacked or leveraged yield, but the way I think about this is as of right now retail users are giving the gray and yellow bars to TradFi in return for products and services provided. I’m optimistic that as more activity migrates on chain, idle capital can be staked to earn yield for liquidity pools, network level PoS security, peer to smart contract lending, and likely many other use cases.

I do ascribe some value to the products and services TradFi provides, but that seems like a lot to pay for services which haven’t changed much in my lifetime (especially when Web3 is progressing towards high quality decentralized alternative products and services).

This example does assume that TradFi banks can earn a net interest margin of 8.25% (9.0% less 0.75%). Based on some quick research, it looks like net interest margins in recent years are closer to 3%-4% on average, though there are some individual institutions in the high single digits.

Settlement of key payments

In a given month, my household cash outflows are probably 90%+ contained in three transactions: (i) mortgage and property tax payment, (ii) car payment, and (iii) credit card payment. I’m sure this is not the same for many potential Crypto users, but I do think focusing on (i) disbursement or settlement of monthly rent / mortgage, (ii) transportation (vehicle or public transit), and (iii) credit card payments significantly limits the number of entities Crypto would need to embed with (i.e., you don’t have to go for the long tail of every point of sale storefront). Focusing on these high dollar value low frequency events would significantly reduce the number of transactions that need to be settled and keep network congestion low as on chain activities continue to scale.

I suspect this is a challenging strategic task as TradFi has their hands all over these three events and will likely be against change. That said, there are no doubt opportunities to get started, for example TradFi has outsourced a lot of mortgage servicing to third parties and many rental property management companies are using or could likely use software platforms to receive rent payments. Integration with these types of non TradFi or TradFi adjacent companies to enable Crypto rails for settlement could be very productive. I was recently targeted on Twitter by an organization called Spritz Financial which appears to be working towards this goal and will be in beta soon.

If a solution could be sorted out where I could use on chain tokens to settle these three payments monthly, I would continue to move more of my assets on chain. Similarly, If I am able to receive direct deposits in a minimized fee environment and settle key payments in a minimized fee environment, the headwind of a fiat on-ramp and off-ramp are also minimized or possibly obsolete.

This approach is obviously imperfect in both the short and long term as (i) many users aren’t able to get a TradFi credit card and would still have to fund a lot of financial activity via TradFi cash withdrawals, debit cards, checks, etc., and (ii) use of a TradFi credit card as a key tool still subjects users to a permissioned financial system via legacy payment rails.

A quick aside, I have seen some product offerings leveraging Visa or other legacy point of sale rails bundled with Crypto entities. I am suspicious of this long term as (i) settlement still requires permission from a centralized entity (e.g., Visa), (ii) swap rates and fees will likely be overly punitive to retail users, and (iii) the more embedded Crypto gets with these centralized permissioned TradFi entities the tougher it will be to roll out Crypto native point of sale rails in the future.

Reasonable fiat off-ramp

To complete the fiat on-ramp fee example previously noted, if an off-ramp is required to settle payments for goods or services, one month break even yield increases to 61.2%. This level of yield is nearly impossible to find.

To drive the point home on the relationship between fees and yield, here are a couple illustrations of yields and break even points.

The table above illustrates the total yield generated based on (i) 3.0% APY (not easy to find in TradFi), (ii) various levels of ramp fees (down the column on the left), and (iii) different time horizons of leaving assets unused and accruing interest. For example, 1.2% ramp fees and funds held for 365 days at 3.0% constant APY compounded daily produces a total yield of 0.5% on capital round tripped onto and off of chain. Pretty straight forward and I don’t suspect any outputs stimulate much of a reaction. Lets look at the same analysis presented on an annualized rate basis.

The lower the fees and the further out in time you go within the matrix, annualized yield will start to converge on the 3.0% APY, which should not be surprising. What may be surprising to many is the annualized loss suffered by users when the on-ramp / off-ramp fees are high and users aren’t able to park assets for long periods of time to earn yield. If users attempt to use Crypto as a replacement for TradFi banks, pay fiat on ramp fees, earn yield for 15-30 days, and then take those assets off chain or settle a payment on chain, and do this every month as many users do in TradFi…there will be a lot of upset users essentially experiencing credit card or payday loan level fees.

This is a significant barrier to increased use for me. Even if there wasn’t 6-20 day round trip to bring assets on chain and then get back into TradFi to buy goods or services off chain, the fees for on-ramp and off-ramp are too punitive for everyday use. This won’t be solved by any L2 or Alt L1 scaling solutions that reduce on chain fees. This likely is not a focus for many current users as speculation or much longer term investment horizons can absorb these gatekeeper fees, but I think to realize the network effects that I’d love to see there will need to be a solution for this issue.

One additional visualization I find useful is to look at how long it takes (in days) to break even (yield earned covers fees) based on the relationship between ramp fees and APY at various levels

If a user can find 20.0% APY with just a 0.4% on-ramp and off-ramp fee (e.g., typical of FTX and Robinhood based on observed opaque spread fee), the user will hit break even in 18 days and begin to accrue positive net yield thereafter. This assumes zero on chain fees.

Alternatively, if a user can only find 2.0% APY, and uses a higher fee CEX (e.g., typical Coinbase fees are 1.5% transaction fee and 0.5% opaque spread fee), the user won’t cover the on-ramp and off-ramp fees until 753 days. This assumes zero on chain fees.

MVBoC use case summary

Don’t get me wrong…I enjoy figuring out how to stake ETH into stETH, borrow ETH against that stETH to stake into more stETH, then do it two more times to get from 4% APY up to 8% APY…and given on-ramp fees, transaction fees, and off-ramp fees I need to lock up for six plus months to break even…and hope the centralized platform I’ve given custody to doesn’t freeze withdrawals…but I personally think the velocity of adoption will only start to move meaningfully when some basic common sense use cases are ready for broad use.

I highly doubt this is lost on many folks in the ecosystem and I know much of the focus even up to current day has been on foundational network infrastructure, but selfishly I hope leaders in the space think the time is right to focus on these fundamental challenges instead of other shiny object style dApps. Shiny objects are cool, but they’re not for everyone or even most people.

If I’m able to settle all of my major monthly payments on chain, I’d be willing to move significantly more of my financial assets on chain and even receive Web0-Web2 employment compensation direct deposited on chain. It’s not sexy, but I think it would be a compelling narrative to get prospective users interested.

Ideally, the fiat on-ramp and off-ramp requirements essentially go away in the near term as more settlement activities move on chain. The definition of “reasonable” is subjective, but I think the fees to get assets on and off chain for general use shouldn’t be greater than the yield earned in a short period of time (e.g., less than a month. Otherwise, why bring them on chain at all other than purely to speculate?).

My hope is that the Web3 ecosystem starts to move more towards a money system instead of a speculation engine as developer time refocuses to dApps once L1s, L2s, and network security are on solid ground.

A future state where point of sale settlement occurs on crypto native rails is ideal, but doesn’t seem like a the most productive first step in my opinion to make meaningful progress towards a blockchain money system and to onboard the next billion users.

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