HK Web3 Festival: A trustless yet trustworthy financial system

HK Web3 Festival: A trustless yet trustworthy financial system

April 18, 2023

After years of restrictions, the Hong Kong Web3 Festival 2023 marked the official reopening of the global city to the rest of the crypto world. The event was attended by over 10,000 visitors and featured discussions from over 300 speakers, with a large number of participants flying in from outside APAC to connect and collaborate with leaders in digital assets and Web3.

Hex Trust’s CEO and Co-founder Alessio Quaglini was a keynote speaker of the flagship event, where he was invited to speak on the main stage to discuss the implications that blockchain and Web3 have on our perception of trust, responsibility, and authority. 

Trust is an essential part of human societies. With blockchain and Web3 introducing the concept of ‘trustless’ systems, how exactly does it all tie together? Is it really optimal for human societies to be completely trustless? How does our novel technology impose implications on our perception of authorities, responsibility, and trust? 

The role of centralized authorities

Many recent conversations are highlighting the shortcomings of centralized authorities – how they’re a single point of failure, bear the power of censorship, and lack transparency in their decision-making processes. Worst of all, the decisions these centralized authorities make always impact people that are not directly involved in the decision making process itself. 

The past few years have shown these very failures in financial markets: banks failed to prevent the 2008 financial crisis, have manipulated benchmark interest rates, engaged in money laundering activities, or even faced cyberattacks that compromised customer data. This has inevitably led to an erosion of public trust, and highlighted the need for greater transparency, accountability, and regulation in the financial industry.

And the exact same failures have happened in the crypto industry. Managers of centralized entities in the crypto space have committed fraud, misappropriated customer funds, and have shown the same lack of transparency mirroring the traditional financial world. The truth is, if FTX had been operating in a glass box of transparency, it wouldn’t have been possible for Sam Bankman-Fried to buy mansions by the beach, or use client funds to make firm-related investments. When everything is hidden inside a black box…opportunity makes the thief. 

So the big question that everyone should now be asking is: Why do we need centralized authorities? There are three main reasons.

The first is that they’re imposed on us. Governments and regulators that dictate anti-money laundering or counterterrorism financing rules, are imposed on us. There’s very little we can do, and their purpose is to serve the general good of societies and nations. 

Secondly, we sometimes choose to have centralized authorities. As human beings, we don’t want to make every decision in our lives. We prefer to delegate certain decisions to specialized groups of people, which is the case for management of a city’s cleaning services, firefighters, the military, but also the broader management of general affairs of a jurisdiction.

Lastly, we don’t have any alternatives yet. Without government agencies as real estate registries, how do we ensure ownership of our homes? Without Instagram or LinkedIn, what are the other ways we can interact with friends or business partners? We don’t have legitimate alternatives yet. 

The new paradigm

There’s little we can do with respect to the centralized authorities that are imposed on us, or even the ones that we choose to have. Where blockchain and Web3 can really contribute, is the third reason for centralized authorities: that we have no real alternative yet. Blockchain technology, Web3, DAOs, and decentralization prove real potential to disrupt the fact that there are no real alternatives to centralized authorities in today’s world. 

With blockchain and Web3, we can build a new paradigm and democratize services by making the users of the system, the owners of the system. This means users will be involved in the decision making process, and be able to fully control, use, and monetize their assets and data. 

We’ll be witnessing the start of a decentralized economy – one that’s not controlled by central authorities, one where users have more power, one where users can earn a higher share of revenues, and allow them to directly influence the direction of the system. Centralized companies like Facebook, Twitter, Instagram or Binance can be replaced by decentralized platforms, systems owned by the users themselves. 

But we must not forget: with ownership, comes responsibility and accountability. 

On one hand, users have a vested interest in the success of the system, to ensure it is secure, reliable, and functional as intended. There is shared responsibility and accountability among the community, and users are actually incentivized to actively participate. 

On the other hand, responsibility and accountability can be its own burden. Being your own bank is a lot of work – not everyone wants the problem of managing their seed and private keys, not everyone wants to put their savings into stablecoins that aren’t reliable, and not everyone wants to be exposed to scams that can empty your wallet on a daily basis. 

When putting the responsibility and accountability trade-off into question, we can see that decentralization is not a universal solution for all our problems, but rather a tool that can be used selectively. When the burden of ownership, responsibility, and accountability is too cumbersome or risky for users, a more centralized system or a hybrid one can be more appropriate. 

Trustless systems, still require trust

Understanding the burden of responsibility and accountability that comes with trustless systems, we must now start designing systems with an acceptable tradeoff between accountability and trustlessness. But the catch here is that we probably cannot build a society that is completely trustless. We still need some element of trust. Because without trust, we wouldn’t have a need for money, or even a human community to develop something better, together. 

To dive deeper into this, let’s look at money. 

We tend to think of money as the foundation of our economy. But money is actually just one layer of a complex system built on top of other foundations, with each layer representing a different level of abstraction and complexity based on a different set of assumptions, beliefs, and social constructs. 

We’re always talking about Layer 2s in the blockchain space – these Layer 2s are equally present in the traditional finance space. Credit cards, cheques, and paper money are all Layer 2 technologies that are scaling technologies for Layer 1: fiat money, and gold. We need Layer 2s, because we can’t go on trips with gold, or use central bank claims to pay for our expenses. 

So if gold and fiat currencies are Layer 1s, what are they built on? The foundation of money – the Layer 0 – is credit, which in turn, is based on trust. 

Credit allows individuals and organizations to borrow money from others, with the expectation that they will pay it back with interest. This way, borrowers are incentivized to honor their obligations in order to maintain their creditworthiness and reputation. Every banking and financing system is based on credit, and the purpose of Layer 1 money, is to make this credit fungible. 

Let’s think about this with an analogy. 

Imagine you are gathering with friends for a BBQ where everyone brings a dish or drinks to share. There’s no expectation of calculating the exact cost or value of each offering. Instead, people contribute what they can, and the focus is on sharing and enjoying the experience together, rather than keeping track of exact costs or repayments. And if a friend helps you move to a new apartment, you don't owe them moving services in return. Instead, you can offer to help them with their home renovation, or return a favor of a different kind. 

The value of the favor might be hard to quantify, but that's precisely the point: without knowing the exact balance of payments, you each feel in debt to one another, and that's how trust is built.

Money, of course, makes things more precise. Instead of returning a favor, you repay someone the exact amount you owe them. But that also means that you're no longer building a relationship based on trust and mutual indebtedness. A community where every debt is exactly paid in full, is no community at all, and this is why credit is so important.

Credit allows us to build relationships and create trust without necessarily having to quantify the value of everything we do for each other. It's the basis of fractional reserve banking, which is what allows us to buy houses, build factories, and go to college without having to save the full cost of these things in advance. Credit is based on trust, and trust is based on relationships. 

So where does Bitcoin fit into all of this? 

Bitcoin is Layer 1 money, which means it’s built on credit like every other form of money. If Bitcoin were to replace fiat currencies as base money, banks would still issue Layer 2 money - or claims on Bitcoin - the same way they currently issue claims on dollars. And some of those claims would be less than fully backed, but we'd still use them because we'd want the yield they offer. This would reflect fractional reserve banking, just without a central bank. 

But is this really what we want? A financial system based entirely on precise, over-collateralized lending, without room for trust or relationship-building? Or is there a possibility for a different financial system, one that's based on uncollateralized lending and on-chain identity? 

Perhaps with decentralized finance, we might just be able to scale communities based on trust, rather than on money. After all, credit predates money - and maybe it's time for credit to take center stage once again.

Best of both worlds

We’ve explored the complexities of trust in centralized and decentralized systems, and the role that centralized authorities play in maintaining trust, and the responsibility that comes with decentralized systems. We’ve also looked at the importance of trust in a human system, and the challenges that arise when trust is absent.

So here’s an open question as food for thought: Can we build a decentralized system that is not only trustless, but also trustworthy? Can we create a system that combines the best of both worlds, where the benefits of decentralization are preserved, with trust baked into the system? 

Such a system would make the decentralized economy more scalable than what it is currently, and will require collaborative effort and innovative thinking from each and every one of us in the Web3 industry. Perhaps it’ll be the next step of development required for the blockchain space to grow.

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