June 10, 2024 | Read Online

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"The single biggest problem in communication is the illusion that it has taken place."

— George Bernard Shaw

Finance is messages all the way down

Here's something that thinking about crypto finance has made me realize about traditional finance: With the exception of physical cash and security certificates, financial assets are never "sent" anywhere — the only thing that ever gets sent is messages.

Visa, for example, is simply a messaging system.

When you tap a credit card to pay for your daily super venti flat white with an extra shot of espresso and extra steamed milk, Visa instructs your bank to deduct $16 from your account and instructs whatever bank Starbucks uses to add yet another $16 to their account.

Barring offsetting transactions, the two banks then send messages to the Federal Reserve instructing the central bank to adjust its ledger of Fed master accounts accordingly, adding $16 of reserves to one bank's account and subtracting $16 of reserves from another's.

To the extent any money has been "sent," it's been sent from one part of the Fed's internal ledger to another.

This is oversimplified, of course, but if it's good enough for Ben Bernanke, it's good enough for me: "We simply use the computer to mark up the size of the account," is how the former Fed Chair explained the process of moving money in 2009.

Prior to the Fed, US banks had to reconcile their accounts by physically delivering cash to each other, but no longer — now it's just messages that get delivered.

The Fed "marks up" its ledger of reserve dollars according to the messages it receives from banks, and the banks adjust their ledgers of our personal accounts according to the messages they send each other.

Sometimes those messages get garbled, as was recently the case with Synapse, a software company that maintained ledgers on behalf of fintechs offering banking services (without themselves being banks).

Like Visa, Synapse was basically a messaging service.

Unlike Visa, it wasn't very good at sending messages: "We had a lot of code that was always broken," a former Synapse engineer told Forbes.

The result was that the banks that relied on messaging from Synapse could not update their ledgers correctly, causing $50 million to go missing.

Perhaps counterintuitively, however, the money wasn't missing because it had been sent to the wrong place — it was missing because the internal ledgers of the banks using Synapse no longer agreed with each other.

In traditional finance, money that cannot be reconciled is money that no longer exists.

Such is the danger of a banking system composed of many thousands of siloed, non-interoperable ledgers.

Crypto, of course, fixes this.

Sort of.

Crypto is DIY banking

The realization that traditional finance is one big messaging system has led me to a new, preferred definition of crypto: Crypto is a financial system of shared ledgers in which everyone sends their own messages.

Not very Number Go Up, I know — but maybe instructive?

Looking at the digital wallet on your phone will give you the impression that the tokens you own are in your wallet — but that's not any more true than the idea that your dollars are "in" the banking app that's also on your phone.

So, as in traditional finance, when you "send" crypto from one wallet to another, the crypto itself is not being sent — what's sent is a message instructing a blockchain on how its ledger should be updated.

The difference between traditional finance and crypto finance is simply that in crypto, we send the messages ourselves.

This has its pros and cons.

The advantage of crypto's shared ledgers is that control = ownership.

Access to your crypto assets is not reliant on an intermediary like Synapse keeping accurate books and records, or on a bank's compliance officer agreeing that you should be allowed access to your own money.

Control = ownership is, however, also the disadvantage of crypto.

If someone gains control of your assets, they're no longer your assets, as demonstrated yet again when the DMM Bitcoin exchange lost $300 million of customer assets in a hack last month.

This compares unfavorably to TradFi, where the bitcoin you hold via an ETF at Fidelity will never be lost to a hack — because even if a hacker gained the ability to move it, where would they move it to?

Securities like ETFs can only be moved from one part of a ledger kept by the DTCC to another, and in the case of a hack, the DTCC would simply ignore the instruction to move it.

Legally, money and assets have only been moved when all the banks involved have updated and reconciled their internal ledgers of customer accounts — and even then the ledgers can be unreconciled, reversing an unwanted transaction.

TradFi banking may therefore be seen as a closed system of reconciled ledgers from which no assets (other than physical cash or security certificates) can escape.

If so, I'd argue that the defining feature of crypto finance is that it's an open system of ledgers that we all immutably reconcile ourselves.

For better and worse.

— Byron Gilliam

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