Money Infrastructure is Corruptible

Money infrastructure, or the system by which our finances move and operate, has been relatively unchanged for the last 50 years. This has created stability, prosperity, and, most importantly, trust. The financial system has been one of the most trusted global organizations, potentially the most trusted global organization. We rely on it for the wellbeing of our society; without it, the world would fall into chaos.

Unfortunately, this has given those who control that system complete power over everyone, and they use that control to extract value for every action. We trust banks to have our money and to keep it safe. But do they?

As of March 26, 2020, the Federal Reserve in the US reduced the reserve requirement ratio to zero percent. This means that banks are not required to keep any of their deposits in a vault; they can lend out everything they have. While this was meant as a response to keep financial institutions afloat during the COVID pandemic, it has not been increased almost four years later. It’s a crazy notion that the money that you deposit in your bank account may not be there anymore, having been lent out to other individuals or businesses. Check your bank balance now. If the bank declared bankruptcy right now, you would likely never see any of that again.*

*The caveat I’ll give here is that your deposits are insured up to $200,000 by the FDIC. However, the FDIC can’t insure everything. While they guaranteed all of the deposits when SVB collapsed, they don’t have enough funds to do that for every instance of a bank collapse. They ran into issues when First Republic started to fail, and were only saved when JP Morgan agreed to buy them out of bankruptcy and guarantee all deposits.

We’ve seen time and time again that financial institutions have made decisions with our money that have cost us dearly. Just in the last 20 years, we can point to the 2008 financial crisis, Silicon Valley Bank, First Republic Bank, and FTX as examples when the financial system bit off more than it could chew.

We can also look at the de-banking phenomenon in modern banking. Bank customers more and more are being flagged as risky, even if they don’t violate any banking rules or regulations. Banks will simply close their accounts, often with little or no notice, and often with little reasoning. The banks do this to protect themselves and avoid extra reporting costs for certain actions or associations (for example, buying crypto). But it can leave consumers, most of whom are innocent of any illegal activity, with few options and the hassle of needing to open a new bank account elsewhere.

A lot of this comes down to risk. Banks are very risk averse, and are incentivized to reduce as much risk as possible. In addition to de-banking customers, they are also encouraged to keep the system as it is, preventing them from adopting technological innovations that could create easier or more efficient KYC/AML checks, better liquidity, or greater customer autonomy.

“The system works [for us] as is, why change it?” - some regulator, probably.

Why is it that the system works the way that it does? Why, even after so many missteps, has the financial system remained relatively unchanged? The main reason is, there’s a huge incentive for banks, investment funds, and other financial institutions to keep things as is.

Almost every financial institution builds delays into their systems to reduce risk. Inherently, this makes sense; why would banks take on more risk than necessary when they could add a time delay to ensure that they can settle all requests properly. In fact, many banks have strategic delays built into larger transactions to ensure that they can fulfill everyone’s business needs. However, in an era where both people and institutions are demanding T+0 settlement times, banks must learn to adapt. You’ll notice that many banks have withdrawal limits, Venmo takes 1-3 days to process when you cash out, and refunds take 5-10 business days to hit your account. Each of these is by design. Institutions are quick to take your money (notice how deposits process instantly), but slow to give it up.

Interestingly, when you look at emerging fintechs, many offer instant settlement opportunities. Many startups have built new risk models, financial tools, and back end systems that can solve this problem. However, banks are resistant to implementing… because of risk. It is risky to try something new. It is risky to give up absolute control over their clients’ money. Those in control of money infrastructure keep it from improving in order to maintain their power over others. Why? It creates security for them. Banks have been deemed “too big to fail”, essentially giving those banks a free pass to do anything they want. They will always subsist because they must; we as a society are reliant on them. If they collapse, we collapse. This puts them in a massive position over us, and a massive position over our world. Imagine if JP Morgan decided that it wanted to close its doors and hoard all their assets. The world would come to a standstill! It’s a remarkably dangerous place to be in, and the system has been designed to work in their favor to maintain it.

So what is the solution? What can we do in an environment like this? Clearly nothing drastic can be done that would upend the balance of power; that would cause chaos and hurt everyone. But we can start to chip away at the power of the banks. We can start to build up a new normal in banking and finance. We can move towards a self-custodial system.

Self-custodial banking is exactly what it sounds like: you control your own funds. Many people scoff at this idea, calling it “keeping money under your mattress,” but it can be much more sophisticated than that. We envision a system where you control your funds, but you can still access secure, encrypted systems for your money, investment products to grow your nest egg, and lending protocols to borrow from for bigger expenses. Imagine building a system where, instead of the banks having power over users, users have power for themselves. They can make the decisions to lend out their money for mortgages or business loans, or keep it in a yield-earning account. They can choose to transfer payments that can settle instantaneously. They can maintain private finances that aren’t publicly viewable in a blockchain explorer. This is why Polybase is different. We’re shifting the paradigm and building something that hasn’t been done before. And we’re just getting started.