The legacy financial system is beginning to crack. Over the weekend, people panicked over Silicon Valley Bank's inability to honor withdrawal.

Money/fiat is funny. It is never really, fully yours if you hold it in a bank. When you entrust the bank to save your deposit, they are entitled to use it in various forms of investment. It’s called fractional reserves, and it’s bad because when every customer wants to withdraw their money at the same time, they won’t have enough cash.

In the case of SVB, customers’ deposit is used to buy government bonds, which due to rate hike, their value have plummeted lately. When you withdraw your money out of the bank, they’ll have to sell the bond at loss. Then there’s not enough money for everybody because of the losses. And no customers want to get less money than they deposited.

Bank failure strengthens the crypto case on self-custody and decentralized money

If only there was a means to custody your own money securely without any help from a third party. Yep, blockchain technology is here for that exact reason.

Crypto assets like Bitcoin and Ethereum don’t have counterparty risks. This is unlike how most banks operate today where you entrust your wealth to somebody else, and you practically are in the dark about how your money going to be used by the banks — and they will use it.

Why could bank failure erase a large swath of wealth?

With the current banking system, capital is centralized, as in its locations. Combined with capitalism, over the years we are seeing capital concentrated in institutions that have become ‘too big to fail’.

The amount, the location, and now, with human money managers who can do anything with the capital, recklessness is bound to happen. Is a general rule in investing that when the money gets larger (the amount), the harder it is to invest it.

It is better if wealth is dispersed among many hands of individuals and institutions. Especially for most individuals, the reason they put money in the bank is just for safekeeping, not being engaged in speculative investment. A hardware wallet does it better than bank workers with how fractional reserves work currently.

Death to fractional reserves

Fractional reserve is a flawed system that won’t go anywhere anytime soon. In The Reasons Why The Government Hates Crypto, I mentioned how Crypto threatens the fractional reserves system.

For the economy is growing optimally, every individual with an income must do two things: 1. Spending, making them consumers, and ensuring demands and economic activities. 2. Savings, but with a quote. Saving here doesn’t mean putting your money under the mattress, but rather lending it to the bank so they can loan it to someone else (eg. as capital to start a business.)

Money shall never be idle. It’s in the big interest of the government and big banks that money is always moving — so the banks can charge fees with every transaction. Crypto doesn’t really fulfill this vision. It does not need middlemen.

Furthermore, fractional reserve banking can create huge leverage that benefits the banks tremendously.

If A saves $100 in the bank, and the bank loans out 90% of it to B, which is $90. B then saves this $90 in the bank, and so on… we can be calculated the final balance on the bank’s book using this formula:

sum = a / (1 — r), where a is the first term and r is the common ratio. In this case, a = $100 and r = 0.9.

So,

sum = $100 / (1–0.9) = $100 / 0.1 = $1000

Therefore, the final amount of balance created out of the leverage is $1000, for a mere $100. The bank would count the $1000 as their assets, not the initial $100. Hence it’s safe to say the whole modern economy, the actual number not counting the leverage is much lower to the point of one-tenth.

Bailouts also strengthen the case for trustless monetary policy

The ending to the SVB bank run is almost anti-climactic. In a move that is predicted by government skeptics, SVB ended up getting bailed out. Of course, they don’t package it that way, and specifically, mentioned that no taxpayer money is used.

Of course, they’re right about the part where they don’t use taxpayer money. Instead, we’re all going to pay it through inflation, the secret tax.

What is this government emergency fund, and where does it comes from? Most likely it will come through the blank check of the FED, which practically has an infinite amount of money. This fund will negate the effect of Powell’s rate hike, as it is putting money back into circulation.

Everything about this screams stupidity, and TradFi just willingly shoots itself in the foot. Bailouts set a bad precedent. A moral hazard. Banks are now even more encouraged to speculate irresponsibly knowing they won’t face any consequences.

The free market crypto economy

Bailouts and government interventions are against the principle of a free market economy. With bailouts, bad decision-making will never get punished. It’s not natural, and threaten the balance of the economy in a various way. (for example, inflation only exist after the FED was established.)

In many ways, we can boast how the crypto economy is much freer.

Reckless behaviors get punished, no matter whether you are small money or big money. (3AC, FTX, Terra/Luna.) The frequency of wealth destruction events in crypto is as often as wealth creation ones. Unlike in TradFi, the government never let the economy fail and experience its natural cycle.

Crypto also has a way to automatically adjust the interest rate — or in crypto terms, yield. It goes up and down based on market data instead of human decisions (i.e. Ethereum Staking Yield.)

Crypto is also a winner in terms of access. As everyone can participate without restriction based on location, nationality, wealth, and other personal characteristics. Everyone can loan, lend, and trade assets. No accredited investors rule no nationality rules and no discrimination.

The volatility of the crypto market, and the unforgiving nature toward its losers, will encourage people to wisen up in the long run. Ironically, this makes crypto less ‘degen’ over time. In fact, there is a growing sentiment that traditional banking practices may be even riskier and more akin to gambling than crypto investments. A joke among crypto folks that’s been circulating around nowadays as news of bank difficulties shows up: Banks are more degens than us, as it turned out.

Centralized stablecoins are our biggest weakness

The SVB saga also unravels our biggest time-ticking bomb: The centralized stablecoins. Circle revealed that it has some of its cash reserves on SVB, to the tune of 3.3B.

Of course, they managed to avoid the disaster as the bailout news comes in. But during the period of uncertainties, we can see the extent of panic across the market.

4. There were reliable non-USD-backed algostables people can run into, such as RAI. However, the liquidity is so low there isn’t enough RAI for everybody.

The industry knows how risky decentralized stablecoins are. It has counterparty risks because the fiat backing is stored in bank accounts. A stablecoin apocalypse is something that always exists in the back of our mind — be it as a joke we uncomfortably laugh at, or some kind of doomporn when we’re in a sour mood.

We just got a peek at it and it ain’t pretty.

Our crypto isn’t exactly ready

The failure of the traditional banking system is a good opportunity for crypto to introduce ourselves — once again — to the skeptics. This is the reason why crypto exists. These are the alternatives we can offer. The world has just witnessed an eye-opening moment on how money, finance, are markets that it knows of are inherently flawed. Silicon Valley Bank's failure will be the first among the money. (As I am writing this, news comes out that bank giant Credit Suisse is in trouble.)

However, I am a crypto proponent who admits that crypto isn’t exactly ready to welcome new capital inflows, especially at the scale of wealth the traditional banking system is currently servicing.

We have a lot of homework, and seemingly endless problems we must solve as an industry. But at least, in many basic things such as the free market principles and sound, trustless monetary system, we’re moving in the right direction.