History has shown repeatedly the apparent weaknesses that exist with centralization or the trust-based model that Satoshi has warned us about.
Under the “trust-based” model, the integrity of an institution is a function of those in control. Rules enforced from the top are guaranteed if those in power are trustworthy.
Since institutional decision making is typically opaque and unpredictable. **Rule changes are at the discretion of those in control**. Sometimes creating misalignment of incentives between the institution and its participants. To add on, institutions may implement suboptimal decisions because of human error/biases.
Due to the capitalist nature of pleasing shareholders and the asymmetric rewards and the limited liability borne by institutions, banks have moved to taking on riskier lending for short-term profit at the expense of retail investors. This is apparent in the 2008 global financial crisis, where many banks got bailed out by the US government. Wall Street walked away with hefty bonuses while main-street bear the brunt – which led to the term **“Privatizing Profits and Socializing Losses”.**
More recently with the CeFi crypto blow up where Crypto Institutions took on too much risk with retail deposits by providing credit to other high-risk taking institutions – 3AC – or generating high yields with unstainable DeFi protocols. Without effective risk management, retail depositors are at the mercy of these institutions. As of today, retail depositors cannot withdraw their funds and, in the event of insolvency, institutions are not liable to repay them.
Both events have something in common where retail depositors give up custody of their assets to a “trusted” institution. This means financial institutions get to own and control them, giving them the authority to create credit in the system and control the flow of capital. While all the profits made from credit creation go to them.
I think we should do better, because web 3 has given us the opportunity of self sovereignty. We should stop giving institutions our keys that allow them to do whatever they like. It is time we take ownership of our assets and be accountable for them.
What if there was a concept of decentralized credit in the economy? Instead of “institutions owning and controlling them”, credit creation is democratized, giving everyday people in the economy ownership to manage responsibly where they can borrow against it or monetize.
Think of it as a self sovereign financial system to complement decentralized money – Bitcoin.