The term “shadow banks” sounds mysterious and sinister, but are they?
Banks in the US are heavily regulated, and became even more so after the 2009 financial crisis.
There are strict rules around risks and reserve capital that limit potential returns.
Shadow banking refers to lending activity that occurs OUTSIDE of the regulated banking world, which can ironically sometimes include banks.
But shadow banking is mainly hedge funds, insurance companies, mortgage lenders and even check cashing operations.
Some elements of the financial world are speculative gambling.
Placing a bet with someone else about a sports game outcome isn’t much different than betting on whether a stock will go up.
It is “zero-sum” which means one person has to lose in order for the other to win.
Long term investing can be positive sum, which separates it from trading.
If I invest my money in your business, we can BOTH win in the end. I get a return on my investment, and you got capital to grow your business.
Insurance is even positive sum. If my house burns down, it would devastate me financially to rebuild, so insurance companies spread that risk across a big group of people.
We both win – I am protected from financial ruin, and insurance companies profit from taking in more than they pay out.
Shadow banking grew from financial institutions looking to get higher returns on their investments, and led to the creation of complex derivative products.
These products include little-understand-concepts of “credit default swaps” and “interest rates swaps”.
They are high risk, which means the returns can be great IF you win the bet. But if you lose the bet, you can lose big.
This world of shadow banking is decentralized and largely unregulated. That is exactly what the blockchain was designed for.
There needs to be transparency so that people can’t cheat, in the same way gambling casinos quickly kick cheaters to the curb.
DLT tech platforms like the XRPL and XinFin’s XDC platform allow financial institutions to exchange value quickly and inexpensively.
Firms like Codius, and Flare Networks offer smart contracts that derivative products need to operate on the blockchain.
Project Ion has proven that equity markets can clear & settle using the blockchain, and when that expands to include the shadow banking derivatives markets, the value exchanged will explode.
This transition will make the current market cap of cryptocurrencies feel tiny in comparison.
Shadow banking is a perfect use case for blockchain payment currencies. Decentralized systems that require speed, trust, efficiency and transparency will thrive using the Internet of Value.