Banks Were Never Going to Be the End of Monetary History

Recent years have witnessed a revolution in the nature of money and the way we pay. While Bitcoin and other speculative cryptocurrencies have attracted the majority of the headlines, the vanguard of this revolution has been led by payment platforms like PayPal, Venmo, and Wise, stablecoin issuers like Circle and Paxos, and software firms like Shopify and Stripe. Today, PayPal alone holds more than $40 billion in customer funds and processes billions of transactions a year collectively worth more than a trillion dollars. And PayPal is just one of many financial technology—or ‘fintech’—firms harnessing the internet to build the future of money and payments.

The question we should all be asking ourselves is why we need this new breed of financial middlemen standing between customers and their hard-earned money? Put differently: why not just stick with good, old-fashioned banks? As I explore in my new book, Beyond Banks: Technology, Regulation, and the Future of Money (Princeton University Press), the answer resides in the first principles of monetary design. As Sir Thomas Gresham observed almost 500 years ago, money is both something that we hold as a store of value and something that we use to make payments. As something we hold, we want our money to be safe. Today, this safety is a product of deposit insurance and the other elements of the financial safety net for conventional deposit-taking banks, together with the bank regulation and supervision that serve as a counterweight to the resulting moral hazard problems. As something we use, we want our money to be fast, cheap and, most importantly, convenient. Especially in the age of the internet, this convenience is a product of new payment technology.

The problem is that the sources of safe money and convenient payments are rapidly diverging. While most people may still deposit their paychecks into their bank account, they are increasingly spending those paychecks using the electronic payment infrastructure built by firms outside the conventional banking system. The reason for this should be obvious: banks are not technology firms. Nor are the vast majority of bankers technologists, software developers, or engineers. In fact, while the financial safety net gives banks a comparative advantage in engineering safe money, banks have seldom been at the forefront of technological advances in payments. Before being popularized by Visa, the magnetic stripe technology long used in debit and credit cards was invented by an IBM employee making ID badges for the CIA. The chip-and-PIN technology that replaced magnetic stripes was invented by Roland Moreno, a French engineer, inventor, and humorist. And the first application programming interfaces that allow merchants to accept ‘card not present’ payments over the internet were pioneered by firms like PayPal and Stripe. While banks have since—and often begrudgingly—incorporated these technological advances into their own products, it is telling that they played little role in their initial development.

Standing at the opposite end of the spectrum are the new breed of technology-driven platforms like PayPal, Venmo, Circle, Wise, and thousands of other firms within the rapidly expanding fintech ecosystem. The growing popularity of these platforms reflects their comparative advantage in using cutting-edge technology to deliver more convenient payments. Yet because these platforms reside outside the perimeter of the traditional financial safety net, they simply can’t compete with banks in terms of the safety of customer funds. Most importantly, unlike bank deposits, these funds are subject to the rules of general corporate bankruptcy law. These rules include an automatic stay that can prevent fintech platforms from returning customer funds until the conclusion of a lengthy and uncertain legal process. Where these customers are treated as unsecured creditors, the application of bankruptcy’s priority rules can also mean that they ultimately get back only a small fraction of their money. In the event of a platform’s bankruptcy—whether stemming from poor management, fraud, operational risks, or catastrophic investment losses—its customers thus stand to be amongst the biggest losers.

The impact of this growing divergence between safe money and convenient payments has been thrust into the spotlight by the recent bankruptcy of the financial technology firm Synapse. Synapse was a so-called ‘middleware’ firm connecting technology-driven payments, investment, gaming, and crypto platforms and their customers with conventional deposit-taking banks. In effect, Synapse would take customer funds collected by its fintech clients and deposit them in accounts with its partner banks. The basic idea was that customers would get both the technological convenience provided by these fintech platforms and the legally engineered safety of banks. Yet when Synapse went bankrupt, these customers quickly found themselves unable to access their money. And recently, some customers learned that they will likely only get back pennies on the dollar.

The Synapse bankruptcy holds out two important lessons. The first is that bankruptcy law is the kryptonite of money: almost inevitably delaying the return of customer funds and potentially leaving customers in the perilous position of unsecured creditors. The second is that the divergence of safe money and convenient payments has led to the proliferation of lengthy and nebulous financial intermediation and data chains, with both customer funds and information passed between fintech platforms, middleware firms like Synapse, and partner banks. These new intermediation and data chains are altering the fabric of the financial system. One day soon, they may tear it.

The emerging consensus in Silicon Valley and Washington is that Synapse was an isolated incident—an idiosyncratic case of bad management coupled with lax regulatory oversight. Terrible for Synapse’s customers, great for newspaper headlines, but of little consequence beyond some minor tweaks to bank recordkeeping rules. This consensus is dangerously off the mark. In reality, both Synapse and the tempest unleashed by its collapse reflect deeper, more systemic, and potentially far more troubling changes unleashed by the growing divergence between safe money and convenient payments.

Faced with this divergence, policymakers have three basic options. The first is to ignore it and hope it doesn’t get any bigger. Over the long term, this seems unrealistic. The second is to close the gaps in the current regulatory perimeter that have allowed these new platforms to emerge and flourish outside the financial safety net—effectively forcing the fintech genie back into the banking bottle. While this option would better protect customers, it would also double-down on our already dysfunctional reliance on banks. In all likelihood, the result would be less competition and innovation in the realm of money and payments. The lack of competition would in turn exacerbate the ‘too-big-to-fail’ problem.

The third option is to harness the forces of change within a regulatory framework that enables technology-driven platforms to combine safe money and convenient payments. This option would entail the creation of a new federal payments charter, designed on a ‘narrow banking’ model, combined with a streamlined regulatory and resolution framework. Chartered platforms would then be eligible to directly access, on a non-discriminatory basis, payment networks and other financial market infrastructure. This option would protect consumers while enabling these platforms to compete with banks on a more level playing field. It would also reduce the length and complexity of the intermediation and data chains that may sow the seeds of future instability.

Banks were never going to be the end of monetary history. Technology changes, customer expectations shift, and business models evolve. The failure of banks to keep pace with these changes is ultimately what has opened the door for the emergence of a new breed of technology-driven fintech platforms. If policymakers make the same mistake, the failure to upgrade our regulatory frameworks may similarly open the door to more debacles like Synapse—and potentially far worse. Just like the opaque shadow intermediation chains at the epicenter of the global financial crisis, they may also eventually grow to threaten the stability of the financial system. History never ends. And while it may not repeat, it sometimes rhymes.

The author’s book can be found here, Beyond Banks: Technology, Regulation, and the Future of Money.

Dan Awrey is a Professor of Law at Cornell Law School.