The Evolution of Finance

Article by Mayank from Finance Wing, GAEE JMI

Times of the Barter System

The Barter System likely began in Mesopotamia in 6000 BC, where goods were exchanged between individuals. This was a widely accepted method of transaction settlement. However, since we have paper money, it no longer appears to be a logical way to proceed.

Nonetheless, evolution has made us sensible enough to reject that system. The exchange took place based on needs. For example, if person C has pineapple and person Y has wheat, trade took place between them. This system dominated for decades.

Civilisations flourished and grew on this system. However, agricultural practices became more common as they settled in large cities. Earlier, people who used to hunt now cultivated. At this point, the trading system collapsed because everyone now had pineapples and wheat—which gave birth to money.

The need for a standard measure

Money and barter have been used as a means of value exchange for centuries. In the past,  beads, tokens, silver, gold, and other commodities were used as money.

It was realised that a more efficient form of value exchange was required. Furthermore, carrying large vaults of gold bullion around was difficult and dangerous because they were vulnerable to attack and theft. Eventually, the past rulers considered centralising all of their precious reserves in one location and issuing bonds known as currencies in exchange. As a result, paper currencies were born.

Modernisation of the money

Initially, the system was unorganised during monarchies, but as governing bodies advanced globally, the system became organised. Banks were mandated and licenced by governments worldwide to facilitate economic exchange.  

Banks such as Hoares began in 1672. It was soon followed by Barclays in 1690. They were government-backed institutions that could be relied on to store value on depositors’ behalf. As a result, banks are the oldest registered companies in the majority of economies. Banks and insurance companies have survived for a long time. It is notable that they are large and still around after two to three hundred years—because they are government trade instruments.

Governments support and authorise banks to regulate a country’s economy. The major innovation was the creation of paper money as a means of exchange, which was supported by the government. This idea was initially met with scepticism. However, once it became clear that the Bank would be able to keep its “promise to pay,” and paper was more practical than coins— acceptance grew quickly. Further, the circulation of the note increased as it spread from merchants to the rest of the population. By the seventeenth century, bills of exchange were used for both domestic payments and international trades.

Cheques, a type of pay order, then evolved. They were initially known as “drawn notes.” They enabled a customer to withdraw the funds they held in an account with their banker and request immediate payment.

Issues with the current banking system

• Inability to access bank accounts

There are always jokes surrounding bank holidays in our country, which means that services are restricted to a certain extent, and the public is dependent on working days. However, isn’t it true that an individual’s needs can never be aligned with the working days of institutions, making it difficult to get issues resolved? 

With the introduction of automated blockchain technology, you no longer need to be worried about accessibility. Since it is a system divided over millions of computers across the world, there will always be a user to verify your transaction or provide you with the service you need. 

• Issues with a centrally governed system.

When an authority is centrally governed, there is a high likelihood that criticism will not be addressed because the governing authority considers itself to be an able policymaker. This can come across as arrogance at times and also prohibits transparency in the institution’s work. 

In other words,  when power is concentrated in one location, if it falls apart, the entire structure collapses. In times like this, the entire DeFi infrastructure ensures smooth operation for its users.

• Hidden fees

Recently, people’s trust in various financial institutions has declined. There are numerous reasons for this decline, but one major issue that has been raised by the majority is the hidden fees imposed by banks on their customers.  Debit/credit card usage, messaging services, internet banking, inactivity fees, card replacement, international transactions, and cash withdrawal when the limit is reached are some of the key services where these are imposed.

Our government has been promoting digital payments for several years. However, it is absurd and hypocritical to impose additional fees on digital payments — which discourages the entire purpose. The DeFi infrastructure ensures that the user is notified of every penny spent via smart contract and that nothing is hidden from them.

• Human errors

There are frequent complaints about signature mismatching in banks, which delays the process that needs to take place. Humans differ from machines. We are not immune to errors and make mistakes at times. Those mistakes prove to be very costly for the person obtaining the respective service in a few instances. The use of smart contracts in transactions and other processes eliminates issues that people have previously faced, i.e., NEFT, demand draughts, and other essential services that need to be processed at a much faster rate.

Blockchain Technology: Revolution in Finance

Introducing blockchain technology, Web 3.0, whose primary focus is on decentralisation and privacy, will be revolutionary in the financial sector. Recently, banks’ Non-performing Assets (NPA) have skyrocketed due to loan defaulters integrating blockchain-based technologies and smart contracts, known as Decentralised Finance (DeFi), which provides services with no financial institutions acting as guarantors.

A smart contract eliminates the vulnerability of relying on a financial institution that can be manipulated and influenced. Thus, eliminating such risks. DeFi refers to financial products and services that are available to anyone with an internet connection. These products and services are always available. Further, there are no centralised authorities to block payments or deny access to anything. DeFi focuses on traditional finance’s flaws, such as:

Inaccessibility to bank accounts or financial services. Financial services are brought down by the government or another centrally governed authority. Hidden charges. And human errors are risky and sometimes delay the entire process. It is also committed to providing you interest in the same way the banks provide interests on your deposits in savings accounts. Still, the key differences are the interest rates and the decentralised tokens.

It is also committed to paying you interest in the same way that banks pay interest on your savings account deposits. However, the key differences are the interest rates and the decentralised tokens.

Essentially, being “deflationary” means that they do not lose valuation or weaken over time. The interest rates offered by these DeFi platforms range from 15 to 25%, ensuring that your money is not sitting idle. Furthermore, the automated verification of payments via blockchain and smart contracts makes it faster and more secure at all times. Several projects want to raise capital for their projects, which they do by issuing tokens of their respective projects, i.e., Terra, which issued the token Luna, and Avalanche, which issued Avax.

These projects use encryption and cryptography to make payments faster,  reduce payment gateway fees, and eliminate the risk of theft. In comparison to the centuries-long evolution of finance, this is a revolution in which every established financial institution must accept and incorporate DeFi into its infrastructure. However, this technology is currently in its early stages. It’s similar to how the internet was in the 1990s—those who predicted the internet’s failure and refused to accept it can see where they are now.

Article Summary: In the barter system, goods were initially exchanged between individuals. Beads, tokens, silver, gold, and other commodities were used as money at the time. Eventually, governments mandated and licenced banks to facilitate economic exchange. The creation of paper money as a means of exchange was a significant innovation. Decentralised finance is the next big thing– a blockchain-based revolution. DeFi must be accepted and integrated into the infrastructure of every established financial institution. Although DeFi is still in its infancy, it has enormous potential.