Trust in Finance Is Dead: Good Riddance

Melbourne, Australia
Thursday, 29 April 2021
Twitter: @DRAUS

[4 min read]

Dear Reader,

Yesterday, I went on a bit of a rant about Dogecoin.

Perhaps foolishly trying to explain something that is inherently inexplicable.

But, foolishness aside, it did get me thinking once more about ‘trust’.

I’m talking about the kind of trust you have in someone or something too. A confidence or reliability in the actions of those around you. Not a ‘trust’ in the legal sense between a trustee and a beneficiary.

Because as I started to touch on yesterday, trust in banking and finance as a whole is on the way out. In fact, all the evidence suggests that it has been for a while now.

Again, as I commented yesterday:

‘It [Dogecoin] gives everyday people the collective power to move markets just as effectively as those who oversaw its collapse in 2008. Putting the power back into the hands of the individual, rather than any centralised authority.’

And it is this idea of power or control that I've been dwelling on a lot recently.

Because the more I think about it, the more I am convinced that the 2008 global financial crisis was the last straw for trust in banks.

A tipping point that not only killed trust, but paved the way for a financial system that has no need for it...

Reputations and relationships in tatters

See, when it comes to banks historically, trust and reputation was always a big deal. Especially prior to the advent of computers and subsequently, the internet.

As a UK report on trust in financial services noted in the aftermath of the GFC:

‘Reputation was of crucial importance for financial service firms, especially investment banks, from the 19th century until the 1970s. Information was typically slow and difficult to obtain compared with the most recent decades, and analysing it correctly was also slow and difficult.

‘Good judgement, based on long experience of markets and those operating in them, was highly prized and highly rewarded. Partners in investment banks that had high reputations could sell their stakes for large sums on retirement, and thus had incentives to maintain the reputation of the institution over the long term, building up long-term relationships with companies and individuals in them, rather than maximising short term profits.

‘Similarly, commercial bank loan officers and branch managers relied on their local knowledge and experience when lending to firms, and the firms themselves typically remained with the same bank for decades.’

If customers couldn't trust a bank, then they wouldn't bank with them. Simple as that.

But, as computers and digital capabilities rose to prominence, things began to change. Instead of increasing the scrutiny and need for trust from banks, it did the complete opposite.

It helped facilitate the rise of globalisation. Allowing banks to gain exposure to new markets and new customers. Investing vast resources into creating new, riskier products with higher profitability. As well as using computers to create complex products and systems as new barriers to competition.

Therefore, shifting the banks’ prerogatives from the more secure, long-term focus to short-term greed.

As a result, trust was quickly replaced with regulation. A poor substitute for preserving the relationship between a bank and its customers. All it did was help prevent rampant greed, rather than cultivate a good reputation.

And even then, regulation couldn't stop banks all the time. As was the case in 2008...

Which, as this UK report concluded, had placed the banking industry in a predicament:

‘Regrettably, but naturally, greater use of computers, and IT more generally, has been partly instrumental in the erosion of trust in the financial system by the general public. Tighter regulation can only be a partial substitute.

‘This makes it all the more important that all those involved in financial intermediation are aware of the dangers of such a loss of trust, and take every care to retain and sustain their good reputation by their deeds as well as their words.’

Unfortunately, in the nine years since this report was published, we have yet to see any bank or financial institution heed this warning.

Which is precisely why cryptocurrency, and more specifically blockchain, is going to replace them.

No trust, no problem

If you’re even just a little aware of bitcoin, you may have heard it referred to as a response to the global financial crisis.

After all, bitcoin and the first blockchain were launched in 2009 — a fairly well-timed response to a period of heightened distrust in traditional finance.

But, in reality, this narrative is just circumstantial at best.

Satoshi Nakamoto, the creator of bitcoin, started working on the project in 2007. Right when the GFC was only just beginning to unravel stock markets and economies.

And more importantly, the ideas behind bitcoin and the blockchain can be traced all the way back to the early ‘90s. Drawing on notions and concepts from Eric Hughes’s A Cypherpunk's Manifesto — which is probably more relevant today than it was when Hughes published it in 1993.

If you have the time (it’s only 850 words long), I would definitely urge you to read it: you can find it here.

Because as Satoshi realised, cryptography could bridge the gap between trust and privacy. Creating a solution to the very apparent problem within the banking and finance industry, as Satoshi stated in 2009:

‘The root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.

‘Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.’

So, in order to remedy this problem, the blockchain was created. An incredible system that requires no central authority or third party to facilitate a transaction.

Instead, by using a permissionless network of cryptographic consensus mechanisms, blockchain had democratised transaction confirmations. Requiring every user and participant of the network to ensure the legitimacy of an exchange of bitcoins, whilst retaining total anonymity.

I know, I know, that was a dense explanation. Using a lot of complex terminology to try and explain something that is notoriously hard to understand.

But, blockchain is only hard to understand because it defies centuries of trade intuition.

Even if we go back to a time before gold-backed currency, before the very concept of money itself, trust has always been at the centre of trade. Because if you couldn’t trust the other person or party, then you’re not going to part with your money or goods.

Blockchain removes the need for trust entirely.

Every transaction happens without the need for a third party. All of which is stored on a publicly available record (otherwise known as a distributed ledger). And, perhaps most importantly of all, is totally immutable; meaning it cannot be removed or undone.

It is the end of trust in finance as we know it, and it is going to change society more than you can imagine.

Which is why I urge you to tune in tomorrow, as we explain how to navigate this bold new frontier of banking and finance.

Regards,

Ryan Clarkson-Ledward,
For The Daily Reckoning Australia