There will be near-universal adoption of the crypto system in the next decade.

Money and banking: A story of values.
There will be near-universal adoption of the crypto system in the next decade, and other predictions.

Full article: https://medium.com/@res_reassure/money-and-banking-a-story-of-values-9c6809f2dc54

“I know of only three people who really understand money.”
JM Keynes

What will you get out of this paper?
This paper is designed to help you understand money.
You need to understand what money is before you can understand the banking system.
You need to understand the banking system before you can compare it to an alternative, the crypto system.
Money is fundamental to life; you need to compare the two systems based on your values.

Who should read this paper?
People who want their money to work harder for them, rather than for big banks.
People who want to know the reason why there are booms and busts in the economic cycle.
People who want to make the world a better place.

Understanding money and banking will help you solve the greatest mystery in modern economics: why does our economy suffer catastrophic breakdowns, causing significant human misery, every few decades? This paper has some clues.

The development of money was a natural part of human evolution: it was driven by our biology and our values. Money arose as an extension of our memory and represented something valuable created through specialised effort, which was used by the group and then, later, exchanged with others through trade. We acquired the concept of stored memory to shift value across time periods. As we specialised further and repeated exchanges across time, this gradually led to the concept of a standard of value, the first step towards money.

Money allowed us to specialise and exchange items of value. Money is often defined using complex language, but it only has two simple, common-sense characteristics:
(1) Money needs to be scarce.
(2) Money needs to be accepted by others as having purchasing power.

Money co-evolved with our ancestors’ discovery of sacrifice. Seeds planted today, rather than eaten with a crop, could mean more next season. Borrowers could repay lenders from what was brought forth by their efforts: when the grain harvest was brought in, a certain percentage was given to those who had sacrificed. Loans and interest due were recorded on tablets and quoted in money. Sacrifice, a form of savings, and the productive use of this savings, benefitted both parties and led to a better existence for humanity.

Money itself is only a symbol, a representation of purchasing power; it is not valuable in itself. Gold, US dollars, bitcoin, etc. have value only to the extent that they are scare and are commonly accepted to purchase goods and services. Since money has no intrinsic value, it must be trusted. The basis of all good money is trust, just as it is the basis for all good human relationships.

Where precious metals were present geologically most societies adopted them as money; they did this because precious metals are scarce. This allowed something that has no intrinsic value to act as a symbol that retains purchasing power over time. The global acceptance of precious metals meant that they could be exchanged for goods and services in ever distant trade and that their value was not tied to the actions of a specific nation state.

As carrying gold and silver around was somewhat inconvenient and risky, the precious metal depositories that emerged issued paper IOUs to customers, like merchants. These paper IOUs, backed by the value of precious metal, could be used for making purchases and the IOUs themselves began to circulate as a form of money. The depositories learned that not all customers demanded access to their deposit at the same time. This presented an opportunity to make loans using paper receipts for more than the total amount of precious metal that they physically held. In this way a “fraction” of the value was kept in reserve and the rest could be lent out. Precious metal depositories led to the creation of banks. Modern banks use exactly the same model today as the depositories from history.

Money: a tale of two time periods.

Money and banking are inextricably linked. The history of money can be broadly divided into two periods: from Neolithic times to the rise of precious metal depositories, when money was linked to value; and, from the rise of precious metal depositories to the present day.

Although this evolved over time, it led to a decisive change in what money meant to humanity:

The rise of modern banking broke the historic link where money represented the memory of something valuable created.

Modern, fractional-reserve banking is characterised as set out below.

   Banks create the vast majority (about 90%) of the “money” that exists in an economy. Through bank charters, society grants the exclusive right to banks to create most of the money supply.

   Banks create money by granting loans to borrowers; these loans are funded mainly by creating matching deposit accounts based on confidence in the bank. This provides purchasing power today in return for future (and greater) cashflows owed to the bank.

   Bank-created money (FV money) is explicitly linked to an asset (the bank loan), which depends on an expected future value.

   This FV money can be used for purchases today in three broad ways:
(1) for productive investment in the economy (e.g. buying equipment or hiring people)
(2) to bring forward expected cashflows (e.g. credit card finance or mortgages)
(3) to finance asset purchases (stocks, real estate)

   The repayment for (1) and (2) are dependent on future cashflow generation. Number (3), for asset purchases, is based on the expectation of selling the asset to someone else in the future at a higher price.

   This third use of funds, for asset purchases, is the main cause of excess variance in the business cycle.

   Banks accept other banks’ newly created money. These create inter-links between banks, globally. Payments between customers cause the recipient bank to retain a fraction of the transferred (deposited) money and lend out the rest, contributing further to money creation.

   If a bank’s loan value is destroyed (e.g. when asset values decline significantly), then the related FV money - originally created by the loan - is also destroyed.

   FV money destruction from the original loan leads to backward, recursive money destruction between linked banks, similar to the money multiplier process for creation on the upswing. This greatly exacerbates economic downturns.

The fractional-reserve banking system.

Fractional reserve banking is an inherently risky activity. The core philosophy of fractional reserve banking is based on dishonesty. The bank tells depositors that it is their money, sitting in their account, and they can have it back at any time. At the same time, the bank lends most of the money to borrowers or uses it themselves, including as an input to their own credit money creation.

If future cashflows needed to support bank loans (and the FV money that they create) do not materialise, recursive credit money destruction causes economic crises and means that the bank may not have enough reserves to cover the lie that they told depositors: that they could have their money back anytime. This is what happened in the 2008 financial crisis, prompting the bail-out of the fractional reserve banking system.    The risk structure of fractional reserve banking is an inverted house of cards.

Here are the top 3 things that banks don’t want you to know.

1.   Legally, you don’t deposit your money with a bank. It becomes their money; it is no longer yours when you make a “deposit”. They account for this money as an asset (since it is legally their property now). In return, you get an IOU, which they call a deposit account. An honest name for the account would be “Unsecured Loan to Us Account” but Deposit Account sounds a bit better.
2.   There is no such thing as deposit insurance. Unlike real insurance, the government doesn’t have a pot of money sitting somewhere to cover your deposit unsecured loan to the bank. What the government will do is print additional money to cover your loan to the bank, if the bank goes bankrupt. This would cause inflation, of course.
3.   Inflation is simply a way of measuring a reduction in your purchasing power. It is better called a Theft Index and is essentially a transfer of value from bank account holders to debtors. Usually, this happens just a little bit at a time, so you don’t notice the missing money. Debtors benefit from inflation because it means that they have to repay less value, in real terms. Who are, by far, the largest debtors in an economy? The government and the banking sector (remember those IOUs?). And, who is mainly in charge of determining the amount of inflation in an economy? The government and the banking sector.

Don’t feel silly if you don’t know this; banks are intentionally opaque. There is a reason you are made to feel stupid or uncomfortable when your mind wanders to thinking about how banks work, or to define what money really is. In fact, in economics textbooks and at business school, they don’t teach you that banks create money; they keep up the deception that banks are just helpful financial intermediaries, the Walt Disney version of how banks operate.

“It is well enough that people of the nation do not understand our banking and money system, for if they did, I believe there would be a revolution before tomorrow morning.”
Henry Ford

Bank regulation, a success story.

Let’s look at the role of bank regulation, which is principally in the hands of central banks. The main objectives for a central banker are price stability and employment. Well, here is a chart of the purchasing power of the US dollar since the inception of the Federal Reserve to the end of 2017.

OK, so the product has lost 95% of its value and you wanted it to be stable. That isn’t so great on the CV. But, it has outperformed almost every other nation state currency and that is why it is the global reserve currency today. So, maybe you could argue in your defence, if you were a US central banker, that your performance has sucked, but it has sucked a little less than most of the others. So, maybe you deserve to stand up a little taller, as your relative performance has been ok. Oh, except against gold. Which somehow has held its value since Neolithic times, even without the benefit of an economics degree. So, central bankers can go home at the end of the day and feel pretty good about their relative performance. Except against that rock.

What about managing economic variance? Well, here is a chart that shows money creation and recessions over the past 100 years in the United States.

OK, so 18 recessions and about 18 booms; that isn’t so great either. Let’s imagine that being a central banker was a real job, like being an engineer and let’s be generous and say that about once in every 10 years there is a system failure. What if we built dams and every 10 years or so they burst? You think people might complain? So, is it impolite to ask: why do we just accept it from bankers?

Here is the key take-away from the graph:

Under a fractional reserve banking system, recessions are a regular occurrence; they are an inherent part of fractional reserve banking. Recessions are the norm, not the exception.

In most important aspects, the impact of banks on the economy is almost completely unregulated. That is because most money in the economy comes from bank credit money creation.

Monetary policy through the lens of a punch bowl.

Regulators’ main tool is called monetary policy, which is where a small committee of government economists with a crystal ball sets the price of money in a (supposedly free-market, capitalistic) economy. Monetary policy mainly and indirectly affects only one of the four main sources of funds for a bank: borrowing from the central bank. This is a small minority of a bank’s cost of funds. The largest source of funds is a bank’s own internal, credit money creation. The cost of this money is not set by the central bank. Banks create this FV money based on their own estimate of the profit potential for creating assets (making loans), based on their own risk-return metrics.

Alan Greenspan remarked that the role of the central bank was to take the punch bowl away just when the party gets going (by which he meant the central bank would raise interest rates when the crystal ball predicts a future upswing in the business cycle; this is using monetary policy to manage the economy). We all know how well that turned out. However, it was his intellectual point that was incorrect, because he doesn’t understand how banks actually operate (or isn’t telling the truth). It isn’t simply an issue of timing. It isn’t simply that the Federal Reserve waits too long to raise interest rates, to pop an asset bubble (or, like 18 of them in the past century).

The correct point to understand about regulating banks is that:

They are not drinking your punch, man.

They have their own punch bowl. And, it is 10x the size of your punch bowl. And, the mix in their punch is a lot more intoxicating than your punch.

Yeah, of course, the bankers come over and drink out of your punch bowl. And, out of the depositors’ punch bowl. But, that is not where the party is.

Your problem, Alan, is WYSIATI. What you see is all there is. You see the bankers drinking out of your punch bowl and you assume that is all they have to drink. Well, if banks only got money from the central bank, then taking the punch bowl away would, indeed, have put a damper on the party. But, this is a relatively small part of what is fuelling their activities.

The proof can be seen in the empirical results. These results are not in favour of a reserve requirement/money multiplier theory of banking, nor the idea that banks only act as helpful financial intermediaries. Nor do the results support the effectiveness of monetary policy in managing economic variances. Raising rates doesn’t end the party. Cutting rates doesn’t bring the party back to life.

This is our modern fractional reserve banking system. It is not at all based on capitalism; it is more like a closed, medieval guild system and it will always exclude out-groups by its very nature. It is as destructive as it is dishonest. It is about as far away from the concept of value, and from our better human values, as you can get.

The crypto system

In 2009 Satoshi Nakamoto created a system of money that corresponds to how humanity has exchanged value for most of our history. Technologically, this system is based on mathematical formulae and a straight-forward verification and record system. The implications are spectacular: you can now trust exchanging value with another person or institution directly, even if you don’t know them.

In terms of values, the crypto system is profoundly natural, a very human invention, based on the concepts of freedom and fairness. It is the most authentic form of money humanity has had since value was based on memory. It is characterised as set out below.

   Based only on PV money (i.e. value that exists today, not tied to any required future value creation).
   Allows value to be exchanged directly between two parties without any bank middlemen, almost instantaneously and at extremely low cost.

A better description than the term crypto currencies is honest money. This money system is about more than just exchanging value; it is also about our values. The crypto system is digital technology to banking and paper money’s analogue technology. The potential, the combination of value and values, that this new (old really) system unlocks for humanity is hard to overstate.

The crypto system is an existential threat to nation state currency as well as to the fractional reserve banking system and to their enablers. It is incompatible with fractional reserve banking. The crypto system is based on a transparent record of truth, captured forever in a giant record book, and on value that exists today.

The fractional reserve banking system is intrinsically dishonest: bankers will tell you that your money is both safely in the bank and, at the same time, they are lending it out to others. They will tell you that it is your money while, legally, it belongs to the bank and they can do what they want with it.

Only one of these two systems can survive. They cannot co-exist together in the long-term. They are not going to be best friends, give each other warm hugs, and talk about a win-win paradigm. Their values are completely contradictory. Expect the banks and their enablers to continue to be relentless and underhanded when attacking the crypto system.

The biggest issue for the crypto system is its lack of connection to the real economy. This comes from the fact that there is no crypto banking system yet. This is illustrated in the form of a puzzle, on the right.

Obviously, a link to the real economy is fundamental to any financial system and this is the main impediment holding back the entire crypto industry.

By bank system, I mean that holders of crypto assets need to have the option to link their savings, a store of their value, to productive opportunities in the real economy.

When this issue is resolved, it will significantly spur crypto adoption. Real crypto banking will be the Netflix moment for the entire crypto space. This will drive the future value of crypto currencies and many existing crypto firms.

If the crypto system can link to the real economy and challenge the core banking of deposits and lending, it will replace fractional reserve banking and benefit all crypto firms. If not, it will remain a niche movement. Banks, and their enablers, will do everything they can to prevent a link to the real economy.

Twenty predictions for the next decade

1.   A new banking model will emerge, in accordance with our better human values.

Fractional reserve banking sucks. Putting the fractional reserve banking model onto the blockchain does not make it suck less. Whether it is traditional banking, challenger banks, neo banks, fintechs, crypto banks: if it uses fractional reserve banking, it is dishonest and dangerous to the economy. Fractional reserve banking is antithetical to the crypto system and the movement of people who support it. A new banking model will emerge, for the crypto era.

2.   Fractional reserve banking will be reformed.

The government charter to commercial banks that allows them to create credit money will become regulated. Internal credit money creation will be subject to regulatory limits. The free government deposit guarantee to commercial banks, which encourages speculation on future asset prices and is the cause of economic booms and busts, will be reformed.

3.   But it won’t matter: the fractional reserve banking system will almost completely die out over the next decade.

The crypto system will offer higher returns for less risk and depositors will increasingly vote with their feet. Over the next decade, the crypto system will expand and the fractional reserve banking system will decline. An inflection point will be reached where the rate of change for both accelerates rapidly. The fractional reserve system is intrinsically structured like an inverted house of cards. Once enough deposits are pulled out of the bottom, the house will collapse.

4.   International trade will increasingly be priced in a standard of value that is global and not tied to the currency of any particular country.

The US dollar will slowly decline as a standard of value in trade. It will be replaced by the Special Drawing Rights basket (USD, EUR, GBP, JPY, CNY) + BTC.

5.   Bitcoin, once linked to productive use in the real economy, will emerge as the ultimate global store of value, mainly because its supply is fixed and because of wide adoption.

Bitcoin will increase significantly in price as adoption spreads. The price a decade from now will be in excess of $410,250 per BTC.

6.   With greater adoption of the crypto system, excess economic variance in the economy will become like some diseases that human ingenuity has confronted: a distant memory.

The crypto system will reduce business cycle variance in two ways:

a.   Through the elimination of credit money creation by commercial banks. Crypto money supply is fixed; it cannot be arbitrarily created.

b.   By endowing money ownership rights in its proper holders: those who created the value in the first place. This will tap into distributed knowledge in society and will naturally introduce greater prudence in use of funds, particularly lending in the hope of future asset price appreciation.

7.   Crypto currencies will be valued more like currencies in the future, rather than like assets, as the sector achieves greater financial depth.

There are two main problems with crypto currencies at the moment: there is little market depth and there is not much of a link to the real economy. In the future, as greater links are established to the real economy, leading to greater market depth, crypto currencies will be priced more like currencies and less like assets.

8.   Most utility tokens will convert into equity tokens or companies will set the price for their product in relation to a stable standard of value, rather than in the token price.

The utility token value is often treated as a representation of the value of the issuing company. Many companies have encouraged this impression, which is economically to the long-term detriment of product adoption. There are two simple solutions: issue securities tokens and/or pricing usage based on a stable standard of value.

9.   Stablecoins will be a very niche part of the crypto space, without much value.

Most stablecoins seek to provide price stability for crypto users, in relation to old standards of value, like the US dollar. While there are some use cases for such tokens, most participants will seek to achieve price stability through more efficient or financially rewarding means. Sellers and buyers of many internationally traded goods, for example, can achieve future price certainty by reference to a stable standard of value and/or using crypto derivatives markets, which will grow in importance in the future.

10.   The future “unwinding” of money created over the past decade will lead to an accelerated decline of nation state currencies over the next decade and drive savers to adopt crypto currencies.

The unbounded and continuing money creation of the past decade, to bail-out the fractional reserve banking system from asset mal investment, is historically unprecedented. Foresighted savers, particularly asset managers in advanced economies, will seek value preservation in the emerging crypto system at a level greatly in excess of today’s levels.

11.   Enterprise “blockchains” will cease to exist.

Their very name is an oxymoron. Enterprises only adopt blockchain as a defensive measure, but they won’t be able to hold off the value that arises within global ecosystems from truly decentralised blockchains. The benefit of blockchains is to cut out the middleman. Enterprises are the middleman. As soon as a real crypto bank is in place, to link the crypto system to the real economy, industry ecosystem blockchains will arise to disintermediate these middlemen.

12.   Centralised trading exchanges will cease to exist.

These exchanges are nothing more than SQL databases and have nothing to do with crypto except the assets that trade on them. Decentralised exchanges will arise.

13.   Money transfer companies like Western Union will go bankrupt and cease to exist.

Western Union transfers money mainly amongst the poorest people in the world. They do this for up to 30% of the amount transferred. The crypto system will soon be able to do this for fixed fees of less than a dollar per transfer. Over the next decade, those institutions that have ethical investing guidelines will disinvest from Western Union, based how it preys on the poor.

14.   Low income people everywhere will do their banking using the crypto system.

The fractional reserve banking system has completely failed low income people. Of course, most poor people are not even accepted by these banks. The crypto system has significantly lower fixed costs than the traditional banking system and, consequently, allows everyone to benefit from financial inclusion. The poor will be able to make transfers at extremely low cost. Emerging crypto banks will allow them the benefits of the savings function, giving them the first opportunity ever to climb out of poverty. The effects for poor communities globally will be transformational.

15.   Micro-everything will explode in use.

The crypto system allows extremely small amounts to be used in the financial system. For example, transfers for only a few dollars can be made. Emerging crypto banks will allow savers to put very small amounts of value to work, on which people can earn interest. The poor will be able to hold just a few satoshis worth of global stocks. Even the yield curve will be able to be constructed on a micro-level, for example the lending function could happen based on a day basis, rather than on wide fixed dates with interpolation between such dates for pricing at the moment. It will revolutionise finance.

These are problems for which the only technology solution is the crypto system. As in so many improvements, the traditional banking system simply cannot offer such solutions; they are stuck in an analogue world.

16.   Constraints due to “repugnance” (for legal activities) will cease to exist.

Economists use the term “repugnance” to describe activities that have a moral element to them. Many banks and financial intermediaries do not allow their customers to make purchases they deem repugnant, even if they are legal. In the future, people will decide what is morally repugnant to them and what is not. The crypto system allows users to decide how they spend their money, not middlemen.

17.   The various financial companies in the credit card processing chain will go bankrupt and cease to exist a decade from now.

The existing cards - banking system is based on pull technology, which is complex, costly and prone to fraud. The crypto payment system, based on push technology, is simpler than and will replace the old system. A decade from now no one will use the pull-based system; it will completely disappear. The main impetus for switching from credit cards to crypto system payments will come from merchants.

18.   Criminals will continue to use the crypto system.

Sadly, criminality is just a fact of life and most criminals use financial systems, including crypto. The crypto system will put safeguards in place to protect against criminal activity, which is possible in a high-tech environment and less possible with traditional banks.

19.   Gold will decline significantly in value, to the price level set by jewellery.

Crypto currencies are superior to gold in all respects and gold’s use as a store of value will be reduced as the crypto system increases in adoption and the fractional reserve banking system and national currency use declines. Eventually, both gold and nation state currencies will be seen as barbarous relics.

20.   Until the crypto system matures, it will continue to attract some bad actors.

The exuberance related to the crypto system’s potential for humanity will continue to attract those who do not have the best interests of others at heart, those who seek only personal gain. This cannot be avoided and all new technologies, from railroads to the internet, attract such characters; it seems it is only human. For those who want to make the world a better place, we need to ignore critics’ attacks against the small number of these bad actors, weed out the opportunists, and focus on providing services that improve people’s lives.

The choice today

Previous great generations had their own battles to fight, whether it was against totalitarian ideologies, against racism, or against sexism. The battle for our generation will be partly against a deceitful banking system. A system that, in the best case, holds us back from living life to the full or, in the worst case, excludes us because we are an out-group. A system that disadvantages the many to benefit the few. A system that preys on our ignorance in order to survive. A system that underpins much of the moral rottenness in other areas of life.

If you want to do some field research, to compare the two systems, go find the Filipino maid standing in line at some foreign exchange bureau. The one who sells herself into slavery to support a daughter back home. So, at least the daughter might have the hope of a better future. Tap the maid on the shoulder and ask how much our modern financial system is going to take from her earnings. 10%? 20%? 30%? What would she get her daughter if she had this extra money? More food? Better clothes? Music lessons? How many years, how much less time away from her daughter would this extra money bring her? And, what interest rate is she getting on her savings in her bank account? Does a bank even give her an account? Probably not.

You tell her that a new system is coming. In this new system, the money she worked hard for belongs to her, not to the bank. A system where sending money to someone will be quick and cheap, like sending information. You tell her that, in the 21st century, we will endure this old system no longer. You tell her that this evil is almost over.

Money is fundamental to life; it is how we keep track of much of our productive effort and how we care for others. It is not simply a question of one technology against another; it is a question of our values. Our choices in the next decade, whether we continue to lend our money to this old, dishonest banking system, will speak to the character of our generation.

In this fight, like all great struggles, we must believe that the human desire for freedom and fairness will prevail.

In this fight, you are either with a community that aspires to make the world a better place, or you are with the big banks.

In this fight, you are either the idealism personified by Satoshi Nakamoto or you are Augustin Carstens.

Robert Sharratt

Robert is part-Canadian, part-British, somewhat autistic and lives in Geneva. He is going to link the crypto system to the real economy and create a better banking model, or die trying. His interests include mountain-climbing, chess, piano, programming and distrusting authority. In his early career, he was an M&A investment banker in London, then in private equity, and then moved to Switzerland to invest his own money. He holds an MSc degree in Finance from London Business School.

ceooffice@reassurefinancial.com