Fiat is worth saving

It’s no secret that banks are broken. 

From Silvergate to SVB, Signature to Credit Suisse, the past few years have underscored the dire need for better banking practices worldwide. But instead of decrying the entire financial system as irreparable, we must focus on the core foundation that drives it all. 

Fiat money.

Fiat money itself is not broken. It’s simply a tool bound by the systems that surround it.

As we build forward, banks and their accompanying traditional financial systems will continue to have important systemic and commercial roles in society; however, they will be driven toward more efficient business models by integrating decentralized blockchain-based solutions. But I’m not referring to bitcoin, ether or the host of the other tokens of the moment.

Instead, it’s blockchain that will introduce transparency, replacing the opaque practices of the past. Rather than hidden fees and convoluted processes, the new financial landscape will prioritize low-cost transactions and cater to user needs. There will be a new streamlined channel for the flow of money throughout the economy. Policymakers will be empowered to modulate supply and demand more effectively, mitigating the adverse effects of economic fluctuations.

Feel like those paragraphs are Web3 fluff designed to capture clicks? Let me dive a bit deeper. 

Money is a tool for collaboration, a standard for storing and transmitting value between people over distance and time. The dynamic and complex economies of the modern world call for money that expands and contracts in response to how they ebb and flow, accelerating during a crisis and braking when they overheat. 

In a modern economy, this is why money is needed: It can help cushion unpredictable economic swings and protect long-term prices and financial stability. 

When banks fail

Today, most of the world’s money supply is created by commercial banks when they make new loans. In the UK, for example, about 97% of money is created by banks. These banks are systemically important financial information businesses designed to help mediate monetary policy. They are heavily regulated and centralized institutions which are tasked with payments, lending and safekeeping money. 

But banks break. Their inefficiency, bureaucracy and opacity contributes to the swings of boom and bust in the economy through, for example, overshoots in monetary policy and unmet financing needs in developing nations (among others). 

As evidenced by a recent McKinsey study, US banks traded at approximately five times lower price-to-book value than tech companies prior to the pandemic. The fact that the capital markets expect a considerably lower return from banks than non-financial information businesses is just one example of how inefficient they are at performing their designated role in society. 

Beginning with Bitcoin (yes, part of the historical ledger but not the end-all-be-all solution), Web3 showed the world how digital assets can be managed peer-to-peer “without going through a financial institution,” making traditional intermediaries such as banks unnecessary for payments. Ethereum extended this paradigm to any imaginable type of financial service involving digital assets, including lending, securities trading, factoring and foreign exchange. 

But where, pray tell, is the interplay between keeping banking systems alive and moving forward with new, efficient solutions?

Decentralizing fiat

The very first generation of DeFi services have already demonstrated the potential of substantial efficiency gains compared to finance. For example, in a 2022 report, Ark Invest showed how the leading DeFi services Compound, Uniswap and MetaMask outperformed established traditional financial companies that offer comparable services by several orders of magnitude in terms of revenue per employee. 

As the Ark study shows, DeFi services unbundle the functions of traditional finance, including what banks do, into smaller composable, stand-alone decentralized applications, which could unleash massive efficiency gains and a wave of innovation in fiat-based financial services. 

The main hurdles for their adoption are regulatory. Firstly, consumer protection and anti-money laundering regulations need to be extended to DeFi, which is a relatively straightforward matter of adopting tools and methods from Wall Street. Secondly, fiat money needs to flow freely within DeFi as “stablecoins.”

But what about the money itself? 

Thankfully, a proven “stablecoin” standard already exists in a major jurisdiction — Europe. It’s called electronic money (e-money) and serves as a “technically neutral […] digital alternative to cash.” First introduced in 2000, e-money is overcollateralized and digitally-native, backed by segregated high-quality liquid assets or bank deposits. Unlike a bank deposit, however, e-money is a bearer instrument intended to serve as a means of exchange. 

Prior to the advent of Web3, dozens of European companies had already issued billions of euros, sterling, and dollars worth of e-money online or as pre-paid cards, including PayPal, Revolut and Wise. E-money is battle-tested — and then some.

The newly passed EU Market in Crypto-Asset regulation requires “stablecoins” to be issued as e-money tokens, thereby confirming e-money as a standard for fiat on-chain in a major jurisdiction. 

With fiat on-chain, DeFi will serve as “open banking on steroids” creating peer-to-peer alternatives to centralized financial institutions and services where none currently exist. For example, in the developing world, micro-, small- and medium-sized enterprises have an unmet financing need of $5.2 trillion every year, according to the World Bank: A gap that the decentralized and global architecture of DeFi is much better suited to fill than the local, centralized financial institutions. 

These solutions will be transparent where old ways were opaque, low-cost where they used to be high-fee and built around user needs rather than antiquated and unfriendly systems. 

Through the evolution of Web3, there is a tangible path toward liberating fiat money from the confines of traditional finance and setting it free in decentralized finance. Together with e-money, Web3 — with its decentralized architecture and peer-to-peer capabilities — is poised to revolutionize the financial landscape. It presents a unique opportunity to reshape the way we interact with money, transcending the limitations of traditional banking, and foster a more inclusive and efficient financial ecosystem.

However, embracing Web3 and transitioning to this brave new world is not without its challenges. Regulatory frameworks must adapt to accommodate this emerging technology, ensuring consumer protection and addressing concerns related to money laundering and financial security. Moreover, comprehensive education and awareness programs are crucial to empower individuals and businesses to navigate this new financial paradigm safely.

The path is clear, and the stakes are high. It is time to embrace this revolution, save fiat money from the clutches of traditional finance, and unleash its full potential within the decentralized realm of DeFi.

Fiat is dead, long live fiat in DeFi. 

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