As a sector, finance has done extremely well in promoting itself as an essential, specialised function of the system, in tandem with but often above government, who both giveth and taketh, but prefereth to taketh.
The financial system had become especially corrupted by its interactions with the political environment, where the systems hierarchical desires have spun more artistic license to the street than the street has had stomach for. The size of the financial sector relative to the economy and market capitalisation of financial institutions relative to equity indices have been a concern, especially the size of the current financial sector, aggressively pumped full of the hot, thin air of a Milton Friedman to the power of Ben Bernanke.
These corruptions of the Finance sector have been one aspect of more widespread cultural events where all types of institutions and systems have been tested in a radical reimagination of how the world works. The analogue environment is out, and everything is becoming digital. That is to say that the linear, rigid structural environment is already a thing of the past. The new paradigm is in the balance of dichotomous forces, the new dynamic is to be dynamic.
It is very early days in this process, and there will be plenty of time to adjust to what it means. At the same time the event horizon that would normalise decentralised finance is not too far away and the rate of change is increasing as fast as the change itself.
The efficiency of such a system in performing what are quite mechanical operations – transactions, security of assets, taking and hedging risk, performing valuations and so on ought to be superior to current institutional banking operations.
As it stands in large banks who do significant institutional business, they are already involved in serious projects with quantitative experts to carve out their trading desks and automate risk processes, having less need for old masters of the universe. Part of the reason why they can do this is that the industry has matured, where markets have become highly sophisticated and efficient, pricing mechanisms are improved and competitive edge is mostly turning up in weird, wonderful and strange 3rd and 4th order places.
So with comparable changes already happening, adaptation is occurring. This type of efficiency-driven automation is maximised in a Blockchain type de-centralised financial system.
So, let’s imagine a de-centralised, global set of quantum computers performing specialised algorithms creating and defending a new de-centralised financial system. Perhaps half of the computers have an active interest in maintaining the system for themselves, financial institutions, trading firms, currency systems or exchanges (now more like banks) and maybe the second half are disinterested such as schools, universities, tech firms and government actors. They are across borders and political jurisdictions by design.
Transactions are immediate, trading occurs in real-time, assets are delivered in real-time, markets are high information with asset specifications and their physical history standardised into blockchain, creating incredibly sophisticated ways of modelling risk with a more or less constant and open appreciation of asset, departmental, institutional, national and global risk available for individuals, investors, institutions, regulators and nations for the entire global financial system.
To focus on a single example, a new global currency is created using the established monetary value of Bitcoin as a foundation. Where Bitcoin maintains the integrity of monetary value, the new global cryptocurrency epitomises the essence of a currency – immediate transactions at high volume, perhaps holding Bitcoin as a reserve of monetary value. Embedded into the system of the currency are balancing mechanisms, where the system has identified the value inherent in it – the value of performing transactions, of holding savings, of hedging risk, as a reference rate and this value is extracted from the system for the system, in order to ensure its operation in good faith.
It is a higher-level concept, a God-level financial system where the things are built as perfect representations of themselves.
There are no shady federal reserve banks with man-made authority, dictated from selected economic theory of the day and dug up based on institutional and reputational significance with what is politically necessary and culturally allowed. The trust that is inherent in the system will be given to the system that most accurately identifies what the ideal system is, that most closely creates the essence of currency, the essence of an ‘exchange’, the essence of ‘insurance’ and so on.
The questions to validate such a system of currency emerges as:
- Does the system identify and create the most currency-like thing?
- Does the system extract the right amount of value from its functionality?
- Does it reward the right mechanics the right amounts to improve its own integrity?
- Is it able to get above its critical mass?
- Is it able to maintain its critical mass for now and in the future?
- Is it an open, self-correcting system with working market-governed balancing mechanisms?
As a result of achieving this, users are no longer pushed into a financial system with a gun to their head where the most politically connected animal thrives. The can is not kicked down the road because the mechanics of the system are reorganised. That system is dynamic, it recognises, accepts and confronts dichotomous forces within it in a sophisticated and systematic way and does not attempt to create strict, breakable structural requirements to control risk. No breaking this bank thank you Mr Soros.
As a result of this the interest rate is the most efficient it can be, repo rates are the most efficient they can be, options are as efficient as they can be, the system is optimised for its own ends without political or “moral” bias – both factors in the Global Financial Crises that has led us to this hyper-real environment.
Instead of trusting institutions, systems will be trusted for their actual mechanics, for the functional mechanisms built to perform in an optimal manner.
Their ability to do this leads to their success or failure, and the option of political bailout will simply not be an option. If it does so, the market rejects their model in a dispassionate and clear way. The individuals involved are not as important as the working models that they develop, and the best system wins.
Atlas never shrugs here, where new masters of the new dynamic digital universe adapt and improve towards optimisation. Even bad actors are trapped within an anti-fragile web of relationships through which they can only improve this idealised mechanism if they wish to operate within it.
Risk will be managed best by people who are capable of viewing things systematically, optimised towards correct game theory and insight rather than betting QE-Infinity. People who derive what the idealised efficient system ‘should’ do will win, and political animals who derive what the system will be coerced into doing will no longer have a place.
Written By: Thomas Kuhn, CFA
Thomas is a 12-year veteran of financial markets working to bring digital assets into the fold of traditional financial markets. With an interest in fundamental analysis with a technical overlay, Thomas actively takes positions in the markets he covers. As well as producing education for traders, Thomas writes for Mine Digital, CFA Asia-Pacific Research Exchange and Hackernoon.
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