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Blockchain is an incredibly powerful and transformative technology offering a unique opportunity to streamline and simplify many financial services workflows. It will enable broad democratization & globalization of financial services, at a significantly lower cost to end users.
But it cannot escape the basic concepts of banking and trust (in Latin, “Fiducia”). As long as a service is provided that requires depositing assets or posting collateral, those assets are exposed to wrongful re-hypothecation, outright theft, re-appropriation or seizure.
For a bank (or bank-like protocol) to function, its depositors need to trust its fiduciaries to handle their assets with utmost care. This is true whether a user deposits money with a bank, a CeFi exchange or a DeFi smart contract.
Blockchain will not change this reality nor will it supersede centuries of principles and regulation meant to ensure financial stability (and manage behavioral patterns of greed or fear on the part of bankers who have fiduciary oversight of third-party assets).
The solution to mitigating bad behavior on the part of crypto institutions or protocols offering bank-like financials services is not self-custody, as tempting as that may seem. No one holds money or gold in their mattress because it’s physically dangerous.
Holding digital assets on your own wallet is akin to holding money in a mattress or a personal safe. It’s as safe as your own physical safety — if someone holds a gun to your head you will likely relinquish your keys or credentials. The solution is regulation and insurance.
Lack of trust in banks (or bank-like institutions and protocols) triggers bank runs. Without a buyer of last resort (i.e. an insurer) with the ability and credibility (supported by both ample reserves and/or a strong physical force) to issue and print its own IOUs, any financial system (whether crypto-native or not) is highly susceptible to significant liquidity drainage.
Crypto-native institutions and protocols providing bank-like financial services will need to decide between adopting local banking charters and regulation in exchange for protection, or they will need to organize and collaborate to create a supranational bailout mechanism.
I anticipate they will do both.