This post is part of my periodic Dispatches from Crypto series and was originally published on Bankless in June 2020.
The early days of the World Wide Web were a heady time for newspapers.
In the preceding years, newspapers had been fantastically profitable with monopolistic local markets, vertical integration, and wide readership.
Then the Internet hit with gale force. First, Craigslist disrupted the classified model, sapping a reliable moneymaker. Then ad platforms and search engines started siphoning off ad revenue, and later stole the content. Social media accelerated the trend, leading to competition for breaking news. Newspaper’s “album model” broke down, with single articles—clickbait—dominating.
It took till almost 2020 for the carnage to stabilize. Monthly subscription services slowly took hold, but only for the most respected national newspapers. By the time it was done, 60% of newspaper jobs were gone and the process of news making was transformed.
In 2020, the target is no less a critical backbone of daily life: the bank.
The humble bank in the age of crypto
American banks have changed dramatically in the age of the Internet.
Mobile banking has become the norm. Checks are now scanned, instead of physically deposited. The Neo banks—Monzo, Chime, Revolut—are ascendant, with a mobile banking focus and continuing innovations (paychecks two days early! free money exchange! fee free ATMs!). In certain payments networks, bank transfers can be realtime. And yet some curious characteristics persist.
Banking hours are still 9 to 5 on weekdays. Physical bank branches—83,000+ in the US at last count—are still critical for collecting retail deposits. Bank transfers still take days (in the US anyway). Regulations protect user funds, but also make it fantastically difficult for most anyone to start a bank. Wire transfers still have high fees and a cumbersome sending process (routing? account? name? address? bank address?).
Enter Compound.
Compound: The Anti-Bank Bank
With just $117 MM in deposits (JP Morgan has $1 TN+), Compound seems a curious bank challenger.
The protocol lives exclusively in smart contract code on the Ethereum blockchain:
pragma solidity ^0.5.16;
pragma experimental ABIEncoderV2;
contract Comp {
/// @notice EIP-20 token name for this token
string public constant name = "Compound";
/// @notice EIP-20 token symbol for this token
string public constant symbol = "COMP";
/// @notice EIP-20 token decimals for this token
uint8 public constant decimals = 18;
At last count, just a few million users in the world have figured out how to access to blockchain. But Compound augurs a seismic shift for banking.
At its core, a bank is a surprisingly simple beast. Savers deposit funds at a low rate. Borrowers borrow them at a higher rate.
The bank makes money on the spread or net interest margin and ensures that borrowers pay it back. Both the bank and government aim to make sure that borrowers don’t all come calling at once, preventing a liquidity crisis.
By that definition, Compound is a bank. Savers deposit cryptocurrency tokens to earn a yield. Borrowers borrow these tokens, but also offer collateral. Compound makes money off the spread. But Compound has a few superpowers that banks don’t.
First, Compound is global. Anyone in the world can access it. Before the Glass-Steagall legislation was repealed in 1999, banks weren’t allowed to cross state boundaries. Today, there are few worldwide banks. Smart contracts and the blockchain make worldwide banks not just possible, but trivial.
Second, Compound isn’t regulated by people, but by code. Banks are highly regulated because they control your money, and can run away with it or poorly lend it. Regular bank examinations protect user funds, but also limit who can start banks, reducing the competition.
Compound does its own regulation: their developers write the protocol—the smart contract programmer’s version of a constitution—and reserve most rights for their users or voters. Not having traditional regulation is a fantastic power for a bank challenger. It doesn’t mean that Compound comes without risk—borrowers can still default and the code can have bugs—but Compound’s owner can’t run away with the funds.
Third, the blockchain—like the Internet—is 24/7 and lightning fast. Compound can take advantage of global transfers that move in a matter of minutes or even seconds. A billion dollars can be sent for $0.50. By comparison, the US banking system is cobbled together from 1970s COBOL mainframes, stitched together in the aftermath of Glass-Steagall consolidation.
The future of financial services
Instead of going bankless, I’ll argue that we are simply redefining the bank. After all, we redefined how we got news in the 21st century through realtime reporting, social media, and news aggregators.
The bank won’t be reinvented overnight. It took 20 years for the full force of the Internet to be felt on newspapers. Users will need to be able to access the blockchain. Smart contracts will have to be debated the way constitutions once were. Risk management will need to become the norm. But the future is already here.
The dislocation won’t stop at banks, but hit much of Wall Street. Since the launch of Bitcoin in 2009, cryptocurrency exchanges have proliferated creating a veritable alternate financial system with 24/7 trading of assets around the world. Smart contract projects like dYdX make shorting trivial and liquid. Exchanges like Uniswap and Kyber allow worldwide trading of any asset at any volume.
Though fintech innovation has accelerated in the last decade, the real financial disruption is just starting.