How Blockchain Can Enable Smarter Financial Products

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Sky Guo, CEO of Cypherium

Arguably the most meaningful use case for blockchain technology is the industry that the bitcoin whitepaper in 2008 initially set out to disrupt: financial services. From financial products like derivatives to institutions like the FDIC, blockchain — as an immutable, absolute digital ledger — has emerged as a way to make these tools and systems more productive and enhance visibility, and it is one that corporations are actively exploring and implementing.

The finance, insurance, and real estate (FIRE) sectors represent the foundation of the global economy, and it’s easy to see why. The capital that they manage is abstract, flexible, and adaptable to any particular economic or cultural development. It also accrues value through lending, as companies and individuals need more money in order to achieve their goals.

From this perspective, it’s easy to see why FIRE might account for as much as 10% of the U.S. national GDP without producing a single good or service. These centralized “nodes,” so to speak, store money and distribute it so other actors can operate with it.

Potential problems arise, however, in the reality that FIRE also bets aggressively on its positions and investments. This greatly exaggerates everything: Though some good investments have made a number of people wealthy, bad investments lead to global catastrophes. Derivatives, in particular, have been a primary tool for FIRE industries to gain an even more centralized hold on the global economy, and they have often done so at the expense of the taxpayer, depositor, pensioner, and homeowner. Most recently, of course, we saw this in the 2008 housing market collapse.

However, betting is not inherently a bad thing. While no technology entirely eliminates the speculative aspects from investing, blockchain’s value proposition is to make these wagers smarter and safer. In particular, smart contracts and security tokens will make forwards, futures, and swaps accountable not only to the small concentration of power who may issue these swaps, but also to the parties whose money is being lent and whose debt is being transferred. Smart contracts can automate any derivative contracts and ensure their terms are monitored and administered fairly, without relying on the arbitration and preparedness of the issuing bank.

Major financial institutions also suffer from inefficiencies as well as a lack of transparency that damage consumers’ bottom line. Similar to most of today’s banking industry, the Federal Deposit Insurance Corporation (FDIC) is purposefully difficult to understand. While it serves an important role in protecting depositors — providing insurance for deposit accounts at U.S. commercial banks and savings institutions — it was also designed to govern manageable crises, not to safeguard depositors in the event of a major economic collapse.

Instead, one of the FDIC’s greatest virtues is its ability to instill public confidence in the banking system, where it should instead be focused on securing a functional safety net.

Insurance serves as a prime example of what makes this so important. Simply put, insurance is a bet that you make against yourself that you will incur a loss. In this sense, the FDIC is a public bet that banks will fail, where bankers and institutions are far less interested in funding such a bet.

As financial technologies become more decentralized, deposits with banks might eventually be considered their own form of contract, either with or without government involvement. Instead of paying a monthly premium to the FDIC, could banks form a consortium chain that is collectively responsible for insuring its depositors?

If so, this reorganization and automation could assign responsibility to the custodian, creating a more foolproof system that saves millions of dollars previously spent on regulating the FDIC at little benefit to the taxpayer.

Perhaps most importantly, viewing deposits as smart contracts — as well as using blockchain to improve processes conducted by financial institutions — would force banks to prioritize their account holders over executive bonuses and government influence. These smart(er) contracts will insure that banks and the government never abandon the conditions that make their deposit-contracts possible.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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