TL;DR:
In this post I’ll introduce the features and services that I value from a retail bank and explore compare and contrast my perception of legacy TradFi solutions and technology relative to the promise of Web3.
- TradFi financial institutions do provide valuable products and services to retail customers, relative to a totally bankless (e.g., pre 1900) construct
- Retail TradFi value proposition peaked decades ago and has been primarily value extractive (minimal innovation and non existent yield on deposits) from retail customers ever since
- I think Web3 is fast approaching a point where infrastructure across multiple networks is established enough to create a portfolio of dApps and provide the key solutions many anons use every month for the vast majority of their financial system transactions
- There are use cases where TradFi continues to rely on human intermediary permissioned actions where programmed smart contracts would be superior. I’ve been on M&A closing calls where hundreds of millions of dollars were released by escrow agents based on verbal confirms from 30 humans on a conference call and associates frantically triple checking checklists.
- There aren’t many examples of killer Web3 apps that have achieved diverse customer acquisition and broad adoption. NFTs and stablecoins with attractive yields have had some success as new crypto users can understand these use cases more easily than complex DeFi and yield farming concepts. Could a more robust bank on chain be the killer app that onboards the next billion users?
These are my opinions. If you have a different perspective on any of these takes or there are different takes which you find to be more compelling arguments for or against TradFi relative to Crypto for retail banking customers, feel free to reply to the companion TWEET to this Mirror post. #Learning.
Ask what your bank can do for you
The crypto economy / Web3 ecosystem is already quite complicated and will only get more complex with time. There are so many different topics from DeFi, to NFTs, metaverse, blockchain games, DAOs, soul bound tokens, L1s, L2s, countless protocols / dApps, etc…it can be very overwhelming. I personally enjoy trying to figure it all out, but there are not enough hours in the day and I doubt most crypto curious or crypto sceptic anons share my sentiment.
As such, I think a lot of soon to be red pilled users that (I hope) will onboard in the coming years will not care about 90% of the Web3 topics or protocols. However, different users will care about different 10% bundles of various Web3 topics and a lot of innovations will eventually find a scaled user base. That said, I do think a permissionless, trustless, decentralized, self custody enabled crypto financial system (or “Crypto”) could get broad adoption when compared to the current TradFi financial system (or “TradFi”).
The flow of value between and among users / humans / entities is a proven global use case that isn’t going anywhere and Crypto removes a lot of unnecessary friction or legacy tech debt from that flow.
The purpose of this post is to:
- Explore the features of TradFi which are key to my financial system experiences and why TradFi innovation was valuable in a historical context
- Make the case from my perspective and personal experiences as to why TradFi banks in their current evolved form simply don’t deliver value to retail users relative to the innovations of the near term realizable crypto financial system
- Consider if a bank on chain could be the catalyst to drive mass adoption and be the first pervasive killer app of Web3
The retail bank value proposition
I am not old enough to to remember a time when the services provided by retail banks were innovative or perceived to be of great value. I can imagine that there was a time this was the case, and I think it likely went something like this:
Physical / digital asset security
Prior to pervasive digitization of the financial system; currency notes, precious metals, gemstones, and other valuables were primarily physical in nature. Before to the advent of banks for retail customers, individuals had to custody their own physical assets in safes, under mattresses, hidden in walls, holes in the back yard, etc. Bank safes, money account systems, and safe deposit boxes were a great innovation and was obviously a more secure alternative for physical security of assets for the retail user.
Catastrophic event insurance
The FDIC provides insurance for USD currency held in bank accounts on account balances up to $250,000 in the case of institutional failure or large scale bank theft. Banks do pay premiums into the FDIC insurance program, however, I suspect that tax payers (or, retail TradFi users) are at least partially responsible for funding or backstopping the program as well. Fraud protection on credit card transactions is a good insurance product as well, though that is fully funded by very high APYs charged by credit card portfolio managers. These are valuable insurance features of bank accounts and credit cards in TradFi regardless of who funds it.
Asset portability and transmissibility
TradFi bank networks and branch offices provided convenient access to assets across various geographic locations. Retail customers were no longer limited to physical assets at their residence or locked only in the local bank safe initially deposited to, and were able to access assets regionally, nationally, or globally. Checks, wire transfers, debit cards, credit cards, payment networks are additional innovations which continued to make money easier to use and removed friction from retail users interactions with TradFi.
Access to credit
Innovations around FICA scores, analytics on customer account activity, as well as the ability to closely monitor actual account balances within an individual TradFi institution’s footprint made it easy for TradFi banks to provide credit to retail customers. Credit extended is typically in the form of high interest credit cards, auto loans, mortgages, home equity loans, etc. Retail customers historically would receive optimal credit terms from their primary TradFi bank based on visibility to financial history and desire to lock retail customers in their banking platform as much as possible.
Permission / validation of credible parties
TradFi banks are intermediaries by design. Retail or commercial account holders ultimately transact with one another, but banks custody the assets and also provide a level of validation of account holders (based on KYC and the assumption that an account holder must be credit worthy if they are a customer of a TradFi bank).
The ultimate goals is to ensure that when an exchange of value occurs, all end use parties (i.e., not intermediaries) receive what they’ve agreed to. TradFi banks in many cases act as the intermediaries underwriting the creditworthiness and trustworthiness of various end use parties.
Ability to transact anonymously
TradFi banks enable retail customers to withdraw cash from branches and ATMs and use those funds to transact completely anonymously. Cash withdrawn could be used to make an anonymous donation to a local charity, support a peaceful political protest, pay for goods at a local store that prefers to evade taxes instead of pay them, gamble at a casino and not report winnings, buy illegal narcotics, etc.
TradFi banks and global governments are completely ok with this reality and, as I understand it, typically only start to ask questions if (i) cash in and out is in extremely high volume or (ii) if they don’t like a user for virtually any reason at all (financial or non financial related).
Reasonable compensation for use of funds
The benefits above are pretty solid. Probably something I would be willing to pay for, actually. That’s not the approach TradFi banks choose to take, though, and instead rely on net interest margin and various penalties and / or fees to fund the cost of products and services delivered to customers. In return, customers surrender their deposits for general use by TradFi institutions.
As TradFi banks settled on the net interest margin approach, all retail users are essentially equally funding the full bank infrastructure. Said differently, If I deposit savings into the bank but don’t use online bill pay, reduced interest rates on mortgage benefits, favorable rates on auto loan benefits, etc., interest I receive on my savings deposit still reflects costs associated with those unused benefits.
A return on cash at the rate of inflation plus a share of interest income earned by the bank seems reasonable. I do not plan on analyzing checking and savings account yield relative to inflation rates, risk free rates, or TradFi return on equity rates, but I suspect that retail customer’s share of the overall pie has trended significantly down overtime.
Again, my focus in this post is retail only and these are generally the features that I value from retail TradFi. I am certainly not a financial services expert so the preceding is simply my perception or opinion based on my experiences and / or observations.
Can Web3 provide a parity or better retail banking experience?
Each of these individual topics will be further explored in future posts, but here are my current summary views as to Crypto comparability to TradFi:
Physical / digital asset security
I think Crypto generally enables superior fungible currency security vs TradFi, as long as users follow some very basic steps to transact securely.
Crypto fungible tokens exist on globally accessible virtual machines and can be accessed and utilized by activating a seed phrase / private key (which can be memorized, written down, or stored digitally depending on your risk tolerance and security best practices). This reduces stored asset physical footprint of nearly infinite value down to the size of a flash drive which can be easily secured and moved as needed.
Self custody empowers Crypto users to safely store assets digitally (minimized risk of physical theft) with digital authority limited only to those granted access (no employees at institutions can be influenced to transfer, freeze, or do anything unwanted to the assets if retail users never share seed phrase / private key access).
Security of non fungible tokens is similar. Non fungible tokens as replacement for physical legal documents to prove ownership is an obvious innovation that will likely come in the future, but will require judicial systems adapt before we can get rid of our file cabinets.
Catastrophic event insurance
Crypto is behind on this topic as far as I am aware. Progress around defining what is negligent user behavior vs victimized exploitation (which should be covered by an insurance program) seems very achievable and would help with TradFi vs Crypto disparity on this topic. I know of slash insurance for staking node operators, but I have not seen wide spread adoption of a purchasable insurance for individual users related to (i) smart contract bugs / vulnerabilities / exploits / hacks, and (ii) phishing exploits, etc. I will research this further prior to a future post on this topic.
Asset portability and transmissibility
Crypto financial system is clearly superior in this respect. Transfer of fungible and non fungible assets is simple, fast, and essentially limitless as to which two parties can interact.
In Web3, fungible currency value transfer no longer requires gate keepers to enable withdrawal of large amounts of physical currency, to certify checks, to wait days for wire transfers to clear different banking systems, or for users to write or deposit checks which may bounce. Perfectly portable, perfectly transmissible. Fees at the individual transaction level in some cases appear to be more punitive in Crypto, but this can be a tough comparison to do accurately based on the TradFi approach of charging fees for certain activities and using net interest margin to cover the rest at a portfolio level.
Access to credit
Crypto is also behind on this topic to my knowledge. While credit is available, it is typically overcollateralized and expensive relative to TradFi. I think this can easily improve as users scale (i) financial activities executed on chain and (ii) assets held on chain. Additionally, willingness of users to connect all of their wallets into a mosaic view of their on chain profile (across L1s, L2s, etc.) will enable a complete picture of user creditworthiness.
Permission / validation of credible parties
At the basic level I think Crypto is superior to TradFi on this topic. When users are transacting, if a user cannot commit the fungible or non fungible tokens required for the smart contract or transaction to execute, then the transaction fails. So, the smart contract or the network layer is acting as the intermediary to verify the users can transact satisfactorily.
I’ve been on the phone in TradFi when anons were looking at various checklists and legal docs to simultaneously release wires for hundreds of millions of dollars at an M&A closing. It was pretty intense. This is an extreme example for this retail user context, but the concept is the same in that humans programming and stress testing the conditions which must be met to clear a transaction seems at least as good as trusting that humans under work stresses have adequately verified all necessary requirements correctly before clearing a transaction.
While I aspire not to transact with users which may have acquired fungible or non fungible assets maliciously, I have to focus on what I can control individually and understand that definition of bad actors is subjective. If all users take security serious, develop best practices, and ideally have access to an insurance program, risks of retail users transacting with bad actors should be minimized and the impact to victims also minimized. Continued improvements in smart contract security, smart contract audits, bug bounty programs, etc., should continue to minimize risk, enable transaction scalability, and reduce overall costs to users.
Ability to transact anonymously
I’m sure you’ve heard plenty of Web3 naysayers pontificate about how there is so much fraud and nefarious activity transacted on the blockchain. It can’t be proven, but I suspect that the vast majority of illegal activities are settled in suitcases full of $100 USD or 100 EUR notes, completely anonymously. Unlike crypto transactions, there isn’t a blockchain we crypto natives can point to and highlight the issue when a bribe is paid in cash or when a large shipment of drugs is paid for in USD…so it’s a convenient straw man argument TradFi can make as Crypto exploits can be quantified and observed on public blockchains.
In that context, I think Crypto currently does enable transmission of much larger amounts of value than can be more easily transported in suitcases full of currency notes or value dense commodities (which is bad), but it also provides many more breadcrumbs which enable tracking of funds and potential to identify who the bad actors are (which is good).
Reasonable compensation for use of funds
I think Crypto is a high performer relative to TradFi on this topic. Basic liquid staking yields and liquidity pool provider yields alone offer a relatively low risk way to earn yields backed by the fees generated by protocols (i.e., liquid staked ETH is backed by Ethereum network fees, liquidity pool fees are backed by swap activity within the respective pools, etc.).
These types of yield opportunities on chain are essentially democratizing some of the very basic activities that TradFi is still charging users for, even though the processes are easily automatable with technology. TradFi’s fees for these types of activities were likely justified even a few decades ago, but the technology now exists to enable value accrual based on capital to go to the providers of capital, individual retail users (not to TradFi institutions in the form of net interest margin to be reappropriated to shareholders, high net worth clients, corporate clients, or other preferred entities).
I’m sure that TradFi banks deliver a lot of value to high net worth individuals, corporations, asset managers and traders, etc. However, that is outside of the scope of my current exploration as I think (i) there is a lot of low hanging value to retail users from going on chain and (ii) that Crypto is more fluid than TradFi which will remove friction from the system and continue to unlock global commerce. As retail users push for on chain settlement, I think non retail non intermediary entities will be pulled on chain once network effects are obvious and broader adoption of public blockchains is more widely accepted.
A key assumption made in the commentary above is that essentially all financial activities can be done on chain and that a cumbersome fiat on-ramp / off-ramp is not required. This is not currently the case, but continuing to enable more on chain activity and / or significantly reducing the cost of on and off-ramps is key, in my opinion.
Can a retail bank on chain be the killer app that drives adoption of Web3?
All of the exciting and new innovations that will sit on top of the blockchain will have a much larger addressable market if the Web3 community can structure and evangelize a basic and compelling reason for users to get on chain.
PFP and 1/1 NFTs, for example, are a fun and highly volatile use case for a certain user profile, but in current form I personally don’t see PFP or 1/1 NFTs as a 1 billion+ user use case with any sort of regularity. NFTs enabled me to get comfortable with transacting in Web3 as I think the UX is currently better than DeFi or other more technical uses, but many users are much more close minded than I am and won’t be ok with spending thousands of dollars on a stick figure JPEG. Metaverse and continued NFT tokenization of physical assets could certainly expand user adoption in this area, but there is still a lot of work to do there.
The Anchor protocol also achieved a lot of success onboarding users with a boring savings account that appealed to those with a basic understanding of personal finance and the power of compound interest. Unfortunately, users perception of a low risk high yield stable dollar pegged token ultimately was a gross overpromise and the resulting death spiral was very sad to see. I spent a little time exploring the Terra ecosystem prior to the de-pegging and will say it struck me as the ecosystem most focused on creating a money system on chain, which is what I want to see as step one for Web3. Money systems are essentially a user TAM of the population of earth plus an additional user profile for every organization of humans (DAOs, LLCs, Government entities, charities, etc.).
I’m am broadly more excited for all of the other innovative uses cases outside of a simple bank on chain, but I think a compelling alternative to the TradFi retail experience could really accelerate adoption of Crypto / Web3 more broadly. I’ll explore what I’d like to see in a useable retail bank on chain in a future mirror post.
Why do you think a Crypto financial system is better or worse than TradFi? I want to hear about it in the replies to this TWEET or in my twitter DMs (@rasmuky).
About the This Web3 Life collection:
Why rasmuky is a Web3 settler:
About rasmuky: