The Crypto Banking Playbook for The Crypto Ethos

After failing to ban crypto, banks are successfully scrambling to catch up. How can Web3 withstand and displace an acrimonious system and thrive on the original ethos of freedom and self-sovereignty.

The Incumbents have always attempted to ban disruptors

This paper about the Telecom industry attempting to combat the Internet industry reminds me a lot of how banks and governments have attempted to prohibit Bitcoin and cryptocurrencies in general. However, as history has shown, prohibiting innovation from protecting the interests of a few has never stopped acceptance nor adoption. “You can either fight it and fall behind or embrace it and allow it to propel you even further,” says Michael Jones on Twitter. Blockbuster, Kodak, Hoover (…) there is an endless list of examples of industry incumbents endeavoring and failing to ban innovative technologies. Banks and governments have used all the tricks to delegitimize the technology, especially Bitcoin which brought Blockchains to everyone’s radar. From labeling Bitcoin as criminal money used for money laundering and as ransomware currency, not allowing customers to use their credit cards to buy cryptocurrencies, closing customers’ bank accounts as they were attempting to withdraw their funds, and even refusing mortgages to customers who have made substantial gains out of crypto trading.

Crypto and blockchain are unleashing unbelievable opportunities to redesign economic models, address inequalities, and break unfair centralized rent-seeking institutions such as banks.

Banks have known that Bitcoin’s technology could gain acceptance for an innovation that would hurt or ultimately displace the existing financial institutions.

After failing to kill it, banks are embracing it and will try to own it

Jamie Dimon’s conflicted timeline

Now the banking industry is racing to catch up. Bankers are becoming more curious, and even legacy institutions such as SWIFT are making noise about adopting Blockchains and praising the technology’s benefits. For the past couple of years, Bank of America filed the biggest number of patent applications in the bank’s history, including hundreds involving digital payments technologies. Banks’ customers are increasingly curious about digital assets. They are asking for more exposure, so the response must be quick to keep them within the bank’s system rather than lose them to crypto exchanges that will allow them to transfer money freely and potentially earn double-digit yields — jamais vu in the banking system.

So how and where to start catching up and embracing Web3?

Deposit Banking and Embezzlement

First, let’s step back and understand the origin of banking and how banks operate. Banks solved the biggest concern of valuable asset owners; safekeeping in exchange for deposit banking or money warehousing. Deposit banking arose to serve the convenience of the holders of gold and silver, who did not want to suffer the risk of theft. In England, merchants who used to keep their surplus gold in the King’s Tower of London were unfortunate to see their gold simply confiscated by the king calling it a “loan” from the depositors. In his book Mystery of Banking1, Murray Rothbard eloquently explains how the House of Lords allowed the mechanism by which banks turned deposits into debt and were given carte blanche in the use of it.

The classic case occurred in 1848 in the House of Lords, in Foley v. Hill and Others. Asserting that the bank customer is only its creditor, “with a superadded obligation arising out of the custom (sic?) of the bankers to honor the customer’s cheques,” Lord Cottenham made his decision, lucidly if incorrectly and even disastrously:

Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it. . . . The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted.

And the author adds: “this form of theft is known as embezzlement, which the dictionary defines as “appropriating fraudulently to one’s own use, as money or property entrusted to one’s care.” Although the money was “placed in the custody of the banker,” he can do virtually anything with it, and if he cannot meet his contractual obligations, he is only a legitimate insolvent instead of an embezzler and a thief. All men are subject to the temptation to commit theft or fraud, and the banker’s warehousing profession is no exception.”

So bankers have taken the carte blanche and turned gold deposits into receipts that served as surrogates. And the more the asset was fungible, the greater the temptation to issue more receipts, to the point where fake or counterfeit receipts were printed. The American banking system was built on top of the confusing and inconsistent Foley case, which led to the growth of a pernicious and abusive industry while legitimately ruling the world of finance.

Crypto custody as banks’ opportunity to slowly siphon crypto assets

200 years later, banks are still using the same strategy. It is unequivocal that they are bringing a massive inflow of institutional capital to fuel Web3 development and unsurprisingly, particularly into asset custody (ex-safekeeping) companies. The recent acquisitions and partnerships Blockdata has put together are quite eloquent.

According to the table above, banks have made significant moves in the so contentious crypto assets custody by either developing their in-house solution or acquiring crypto custody technologies and services or outsourcing to sub-custody partners.

Assets custody is a huge opportunity for traditional custodian banks to service their asset management clients, looking to offer institutional investors exposure to crypto trading services. For example, while BlackRock uses BNY Mellon, Citigroup, and JP Morgan as custodians for traditional finance, it chose to partner with Coinbase Prime to provide crypto trading, custody, prime brokerage, and reporting services to Aladdin’s client base (BlackRock’s portfolio management software). This huge opportunity is a smart way to catch up and re-seize control on the next digital store of value.

As embedded in their DNA, banks offer what they do best: safekeeping, which remains the most critical and ambiguous aspect of banking as seen above. Customers will give up their crypto the same way gold holders gave up on their bullion to prevent theft risks.

Get ready for history to repeat when banks will offer untraceable warehouse receipts for digital assets custody and the convenient systems that derive from it. Collateralized loans, fractional reserve banking, hyper-inflation, and all the greedy schemes the chaotic modern monetary system disseminated. And if banks lose everything, customers will learn the hard way about the outrageous Foley case.

So how does the crypto ethos remain the counter-power?

Banks are aware that crypto as a digital asset class and as a modern infrastructure for the exchange of value, is inevitable and impossible to kill. But they also know that regardless of the crypto-enthusiasts warnings; “not your keys, not your crypto,” most users — especially institutions, will unlikely take the risk that comes with the cumbersome self-custody, and will trust banks which would equal to giving water to their enemy’s mills.

In order to succeed and thrive the way it was intended; crypto as a decentralized, permissionless, global and neutral network, allowing the exchange of value freely, it is fundamental that:

• we improve the usability of dApps by enhancing their UI/UX,
• demystify finance and educate the world about money, economy, and finance to properly understand the world we live in,
• build communities to accelerate knowledge outreach, initiate network FX and avoid pyramidal concentration of minds
• empower entrepreneurs and builders by providing coding knowledge and mind-opening experiments
• fund research to build, test, iterate, try new models, explore the dynamics of crypto networks,
• address inequalities by creating new incentive models, and identify and redistribute untapped value among stakeholders.

As a nascent technology, crypto has a long and rocky way to becoming legitimate and accepted. Now that banks are embracing it, they will do their best to have it regulated and fall under their obscure and evil control. However, crypto might not be immaculate, but it is the only recourse that per design can empower people, re-establish trust, enforce accountability and displace monopolies.

So LFG!

1 — Mystery of Banking — Murray Rothbard available for free on Mises.org