Original title: Internet Finance Original author: TheiaResearch, Crypto Kol Original translation: zhouzhou, BlockBeats

Editor's note: This article compares the impact of the Internet financial system with the Gutenberg printing press, arguing that Internet finance will significantly reduce financial transaction costs, break the monopoly of traditional finance, promote the free flow of global capital, and drive economic growth. Through de-licensed cloud servers and smart contracts, Internet finance can optimize capital allocation, risk management, and financial innovation.

The following is the original content (for easier reading and understanding, the original content has been reorganized):

Our fund philosophy is entirely based on the Internet financial system, which is the cornerstone for us to live and die for. We often try to explain the prospects and significance of the Internet financial system to our friends and investors.

This is a difficult task because the existing financial system is mostly abstract to consumers—especially those in developed countries who are content with the existing financial infrastructure—and what we are trying to build is still conceptual and esoteric.

This article brings together some of our classic ideas to help you explain the Internet financial system to your friends, family, and clients.

Together, we are building the Internet Financial System (IFS) - a cloud-based, better financial system that can carry global assets and provide financial services to 8 billion people. We believe that the Internet Financial System is a paradigm shift in global financial activities, just like Gutenberg's printing press brought about a paradigm shift in knowledge production and dissemination.

Unify server and smart contract code

Let’s discuss two fundamental differences between the existing financial system and the Internet financial system, which is the most technical part of the article.

You might think that the financial system already works on the Internet because you can access your bank or brokerage services online, but the Internet is just an interface through which you send your orders, just like you would place an order with a pizza delivery place. Pizzas are not made on the Internet, and neither are your financial transactions.

The existing financial system operates through a series of isolated servers. There are more than 90,000 financial institutions in the world, and most of them use internal servers that are not accessible from the outside. Your bank loan is just an entry in one of these servers. Any asset you have in the global financial system - whether you own it or owe it - is also an entry in one of these isolated servers.

If you own real estate in the United States, you probably know that your title is registered on federal, state, and local servers, to which only a handful of privileged administrators can send transactions. This is what we call the “privileged orphan server” problem.

Financial institutions use standards like SWIFT and ACH to transfer money and share data. However, these standards require multiple steps and manual oversight because of differences between underlying databases. When communicating between financial institutions across borders, you rely on local government agencies like central banks and international institutions like the Bank for International Settlements. The process is expensive, cumbersome, and slow, filled with reams of paperwork and highly paid staff. This is the problem of high transaction costs associated with isolated, privileged servers.

There are two more problems that arise from building a financial system on permissioned servers. The first problem is: creating a financial services company is hard — really hard. You need to find a “gatekeeper” who will allow you to publish transactions into the permissioned, isolated network of servers we call the global financial system.

You also have to pay them well. That's the problem with high barriers to entry for financial startups. Another related problem is that financial institutions have privileged access to the entire region. For example, three banks control more than 50% of the market share in Colombia, and you need to work with them to lend to businesses in Colombia.

A similar situation exists in the market structure of most emerging economies. Each country has local financial institutions that act as "gatekeepers" to market opportunities in their own country and use this privileged position to extract rents. This is what we call the "local banking oligopoly" problem.

Note that so far we have explained the “privileged silo” problem and how it leads to heavy transaction costs, high barriers to entry for financial startups, and local banking oligopoly problems.

In a permissioned server system, establishing a financial startup faces high barriers to entry.

Most countries have some financial institutions that act as “gatekeepers” to local opportunities.

Let's look at one of the core advantages of Internet finance: code that can make promises. This is the basis of smart contracts. Chris Dixon compares smart contract code to a vending machine where you put in a dollar and get a bottle of Coca-Cola. Smart contracts allow you to write code that responds to inputs in a predetermined way. For example, when a smart contract receives a dollar, it can release a bottle of Coke.

Alternatively, it can release the collateral when it receives full principal and interest payments. Smart contract code can automatically distribute dividends to shareholders, rebalance portfolios, and manage equity structure tables according to preset logic.

The beauty of smart contract code is that it allows you to automate most financial activities and expands the design space of financial products you can create. Take an escrow agreement as an example. When you buy a house, the escrow agent holds the funds and the title deed until both parties fulfill their promises and release the assets (for example, the seller cannot take the funds and then fail to fulfill the agreement).

Smart contract code means you no longer need an escrow agent - just an escrow contract that checks both assets and releases them when the right conditions are met. You can automate all kinds of transactions - for example, a loan market that enforces penalties and releases collateral on a payment schedule; a life insurance policy that pays out upon receipt of a certified death certificate; a copyright contract that automatically receives streaming payments every time a song is played on Spotify. The design space is so vast.

The existing financial system cannot use smart contract code, it relies on a network of isolated, permission-controlled servers. The Internet financial system is built on a permissionless, unified server, using smart contract code. So, what does this mean?

The Internet financial system is a step forward for our civilization

1. Internet finance allows capital to flow freely across national borders.

The Internet financial system is global because it is built directly on the open Internet. Physical distance no longer matters. You can send money across the globe instantly for less than a cent. A fund in Dubai can invest in auto loans in Colombia. A hotel operator in Indonesia can raise funds from global capital markets without having to pay high interest to the local banking system.

Most people have seen the statistics on remittances - people send over $900 billion to each other every year and pay an average of 7% in fees. The remittance industry is taxing the world by $60 billion. About $670 billion (about 75%) of remittances go to low- and middle-income countries, where they can account for over 20% of GDP. There is no additional cost to send money over the internet because internet finance itself does not recognize national borders. Sending money is just an update to a unified server and it costs the same as a transfer between any two accounts (< $0.01).

Our existing financial system, based on privileged siloed servers, does not enable the free movement of capital across borders. Each local banking oligopoly uses its privileged position over remittance recipients—control of local servers and access—to extract rents. Using remittances as an example, this dynamic is easy to understand, because we intuitively know that a hard-working immigrant should not have to pay 7% in fees to send money to her mother. By 2025, remittances should cost less than $0.01.

For most of us, it’s harder to observe the same extraction process in all areas of the global financial system because these costs are a layer of abstraction. However, we can approximate the true costs of local banking oligopoly by looking at the net interest margin (NIM) – the difference between the cost of borrowing by a financial institution and the fees it charges for lending. Across the world, regions with less developed financial systems tend to have higher NIMs – typically between 5% and 10%, but this figure can be much higher.

The economic distress caused by excessive net interest margins is difficult to overstate. A banking system with extractive net interest margins means that mortgages cost more than they should. Higher mortgage costs mean fewer people can afford homes, which means fewer homes are built.

This can be extrapolated to the entire economy. More expensive business loans mean hardworking entrepreneurs need to pay more “rent” to local banks, and fewer entrepreneurs start businesses. In Nigeria, a young professional can’t pay her car loan, so she can’t accept a job offer 50 minutes away. Extractive net spreads affect every level of society, and it means lower GDP growth and fewer jobs.

The global internet financial system has addressed this problem by providing large investors with more high-yield and diversified investment opportunities, especially in less developed economies.

Let's say you run a diversified high-yield fund in Dubai and believe that Colombian auto loans offer a good risk-adjusted return. It's not easy for the Dubai fund to gain access to Colombian auto loans under the existing permissioned, siloed server system. The fund could look for a fund of funds (FoF) in New York that has a relationship with a local credit fund in Colombia, but this already involves three layers of fees.

Following the framework of the Internet Finance system, car dealers in Colombia issue auto loans directly on the blockchain. This way, they can find the lowest cost of capital because that is where the liquidity is highest. An algorithm can sort Colombian auto loans according to predicted default rates and allow Dubai funds to precisely screen the investment exposure they need.

You should envision a global system where capital can flow easily around the world to be used for its most efficient purpose; a financial system where net interest margins are compressed to the cost of capital.

Let’s take another example - a hotelier in Indonesia raised funds through the internet rather than paying high fees to the local banking system. Why do we assume that the hotelier would prefer to raise funds directly on the internet? This is because of the important concept of auction network effects.

If you want to sell an old game console, such as a Sega Dreamcast, you will go to where there are the most buyers, because that is where you are most likely to find the highest bidder. Similarly, people who want to buy will go to where there are the most sellers, because more sellers means a higher probability of finding someone willing to sell it at a reasonable price.

This is why most markets tend toward winner-take-all outcomes. The Chicago Mercantile Exchange (CME) dominates traditional derivatives markets, the New York Stock Exchange dominates US equities and fixed income markets, and eBay dominates the global Sega market.

The auction network effect is why we expect the Internet to become the world’s deepest capital market. The Internet will become a marketplace between all types of people who need capital and those who have capital to allocate around the world, providing the lowest cost of capital.

We do not mean to suggest that national financial regulation and capital controls will disappear in the face of Internet finance. Although the underlying financial system will be global and allow capital to flow freely across borders, sovereign states will still superimpose their laws and regulations on top of it.

Just because technology enables you to do something doesn’t mean it’s legal or permitted. You can think of Internet finance as being similar to cars, which allow humans to do things that were previously impossible, but don’t mean they are completely exempt from local laws. However, we expect that national laws will adapt to Internet finance as economic policy and financial regulation have always adapted to technology.

2. The Internet financial system will improve the property rights protection of 5 billion people around the world.

The existing global financial system does not provide secure property rights for most people. While some advanced economies have strong property rights, most emerging markets rely on assets for savings that are vulnerable to devaluation, expropriation, and arbitrary legal systems.

The world’s 20 largest emerging markets, with a combined population of over 5 billion, have an average Heritage Foundation property rights score of less than 43. Such a low score means your property rights are politically dependent and often subject to bribery and favoritism. This means you could invest in a piece of land for ten years only to find out that the local governor’s brother has added his name to the land registry and become its owner.

A score of 43 means you could invest in a local stock only to find that the largest shareholder - a well-connected businessman - restructures the company at the expense of minority shareholders. This means your hard-earned business could be expropriated by a well-connected local, or rendered uncompetitive by arbitrary taxes, penalties and restrictions. Investing in countries with weak property rights is difficult.

If you live in countries like the United States, Australia, or Europe—where most of our readers probably do—you may not fully understand this dilemma, as you most likely live in a country with a property rights score closer to 95.

The world’s top 20 emerging markets have a combined population of over 5 billion people and have an average Heritage Foundation property rights score of less than 43. Weak property rights issues are intertwined with arbitrary money supply growth. More than 80% of the world’s population lives in a hyperinflationary environment – ​​defined as annual money supply growth of more than 12% over the past 30 years. Most people are forced to hold their own currency due to limitations in their local banking systems and payment channels.

There are many ways to lock capital into fiat currencies - controlled exchange rates, high fees to convert to dollars, or even direct government mandates. These currencies cannot survive without capital controls because people would rather hold low-inflation dollars than high-inflation national currencies.

In emerging markets, holding dollars is difficult, and the result is that savings evaporate. On average, local currencies lose 65% of their value against the dollar every fifteen years.

Saving in an environment of weak property rights and high inflation is like climbing a soapy iceberg. You can save in pesos, but over time most of your savings will evaporate; or you can invest in local assets, but then you live under the sword of Damocles of arbitrary property rights.

And we haven’t even mentioned financial exclusion. About a third of adults worldwide don’t have access to a bank account, which means more than 1.4 billion adults don’t have access to any financial system. Even more people don’t have access to credit and good savings options.

Stablecoins provide these people with an opportunity to hold US dollars directly in the Internet financial system without relying on the local banking system. In just five years, the total amount of stablecoins has grown to $200 billion.

The next step in global property rights protection is for the United States to allow trusted companies like BlackRock to tokenize real-world assets such as stocks, bonds, and ETFs through a regulated custody model. These assets will be held by regulated US institutions and the government can seize them from sanctioned accounts at any time.

Imagine Apple, Amazon, Google, and Berkshire Hathaway stocks on the blockchain alongside the S&P 500 and Nasdaq. This would provide better savings options for billions of people around the world while expanding the holding base of U.S. assets.

High-quality assets on the Internet will provide people in emerging markets with better ways to save, which is a positive change in itself. We also expect that emerging markets will strengthen their own property rights protection through Internet financial instruments. A reforming government can put land registries directly on a global unified property rights server to avoid corruption by local governments. For example, companies in Uruguay can embed minority shareholder protection directly into their smart contract code to better protect the legal rights of assets.

This may seem like a naive prediction, but it actually has good mathematical promise. The long-term problem with property rights in emerging markets is that it is very difficult to eliminate corruption, and even if successful, successor governments are likely to overturn these small achievements. Property rights reform is a problem that N governments must solve together, and each government must attach importance to property rights over the long term perspective of multiple generations.

The tools of Internet finance simplify the problem of property rights reform to one that can be completed by a single government. As long as there is a reformist government that puts land registration on the Internet finance system, this decision will be difficult to revoke.

3. The Internet financial system will put global assets on the blockchain and promote financial innovation

The existing financial system does not allow small companies to access the global capital market. This means that smaller companies need to pay more capital costs and rents to intermediaries. The world's 20 largest emerging markets by population include 3.5 billion people and 8,457 listed companies. You can't connect them, for example, Mexico has 128 million people, but only 133 listed companies. This is far from enough.

Even in the United States, similar problems exist. The number of public companies available to investors in the United States once peaked at over 8,000, but has halved in the past 20 years. The listing process is cumbersome and expensive (over $2 million in fees plus 5-7% of IPO proceeds, plus long-term reporting and compliance costs).

We have already begun to see an explosion in the number of on-chain financial assets. For example, Pump.fun — a memecoin launch platform built on Solana — has launched over 5 million unique tokens since March 2024. Metaplex has launched over 9 million non-fungible tokens (NFTs) in the past 3 years.

Many observers underestimate the scale of these achievements because they conflate the quality of the assets on-chain (mostly memecoins and JPEG NFTs) with the quality of the financial infrastructure behind them. In fact, the real signal is how easy it is to launch assets on the Internet once the high entry fees that serve as a barrier to liquidity in the traditional financial system are removed.

We expect that there will eventually be regulatory requirements for token listings, but any reasonable requirement would result in a 90%+ reduction in issuer costs.

Since March 2024, more than 5 million tokens have been launched on the Pump.fun platform.

We foresee a future where small businesses will be able to access equity and debt financing directly over the internet. We have already discussed small business owners in emerging markets. Mid-sized companies in the US will also be able to trade on liquid markets, giving everyone in the world access to the best performing asset class of the past four decades.

The types of instruments used to finance businesses will evolve to accommodate cheaper, more flexible infrastructure. Apple could issue a hybrid debt product that makes daily payments of 10% of each iPhone sold. Starbucks could issue revenue-sharing tokens just for its 200 new stores in the Pacific Northwest, with market prices providing management with feedback on the value of its expansion plans.

The Cambrian Explosion will be reflected in more than just the growth in the number of assets. We also expect the pace of financial innovation to accelerate dramatically. Consider some of the products that already exist in the Internet financial system, which can serve as a harbinger of possible future developments.

1. Universal Margin Accounts allow you to borrow against homes, stocks, Bitcoin, and even assets that would only qualify as collateral in a smart contract-based financial system (like music licensing income streams).

2. An arbitrary option is when an investor draws a payout chart and designs a matching financial instrument through an algorithm, which is achieved by combining existing financial products. Without smart contracts, building an arbitrary option requires an experienced options trading team and several lawyers, but using smart contracts can be done in seconds. The key advantage of arbitrary options is that they provide cheaper and more tailored hedging solutions.

3. Deep and global prediction markets can improve the quality of predictions we use in everyday decision making. In the 2024 election, prediction markets demonstrated their ability to better predict Biden’s unexpected loss and the ultimate election outcome. Imagine if there had been prediction markets in the early days of COVID-19, or the early days of the conflict between the United States and Iraq. Prediction markets are better at aggregating information than most experts and making the best information public. They can help people make better decisions and hedge against global conflicts and adverse election outcomes.

4. Yield-secured credit cards reduce the risk for lenders while increasing interest rates for borrowers. You can hold your property as an NFT and pay for it with a credit card that increases your mortgage limit up to a certain limit. Adding good collateral can reduce interest rates by up to 10%.

5. Decentralized exchanges have reduced the cost of issuing liquid assets by 1000x. This is exactly the example we mentioned earlier, Pump.fun and Raydium. DEX also reduces trading fees for retail investors, who only need to pay a single site fee instead of the 1-5% fees that retail trading platforms such as Coinbase and Robinhood have to pay.

6. The lending protocol allows customers with compatible collateral to borrow, comparable to the competitiveness of the U.S. corporate debt market. On the Euler platform, anyone with an internet connection can borrow USD with ETH at an annual interest rate of less than 7%.

7. Futarchy is a way to make smarter decisions by leveraging the predictive power of the market. A classic example is a fierce activist movement calling for the CEO of a company to step down. The board can set up a futuristic market that allows investors to buy shares based on the current CEO resigning or staying in office. The board can refer to market prices to help make decisions.

These are just some of the “0 to 1” innovations in the Internet financial system. Low barriers to entry allow for low-risk experiments in financial design, resulting in many failed projects, but also some outstanding innovations. Innovation in the traditional financial system is inhibited by high barriers and experimental costs.

Take the example of Steve Budish, a professor at the University of Chicago, who designed batch auctions to solve many of the problems faced by high-frequency trading (HFT). However, Professor Budish failed to convince any large Wall Street firm to adopt his design because existing financial institutions were reluctant to experiment in the highly valuable field of high-frequency trading. Instead, some startup teams, after reading his paper, directly implemented his design in the decentralized Internet, and some of them have achieved quite good results.

4. Internet finance is more efficient

Finance is an integral part of our civilization, and I greatly admire our work in financial services. We work to understand how society should allocate resources, to predict the future, and to fund projects that deserve funding. We consider risk thoughtfully and mitigate it whenever possible. As John Maynard Keynes said, we work to defeat the forces of ignorance that hang over the future and the darkness of time.

However, we do devote a significant amount of resources to maintaining this permissioned, isolated server financial system. In the United States alone, there are 8.5 million financial services workers, which is over 12.5% ​​of the nation's college-educated workforce. Over the past few decades, roughly 20% to 30% of Harvard's undergraduates have gone into financial services. Even at top schools like Yale, the numbers are pretty close.

We can automate a lot of tedious financial work through smart contracts. We have seen some protocols exceed billions of dollars in transaction volume and loan size with small teams. Kamino manages $2.2 billion in capital with just 20 employees (more than $100 million per employee), while Raydium has completed over $550 billion in transaction volume with less than ten employees. These numbers still underestimate the efficiency of smart contracts, as both Kamino and Raydium can grow assets and transaction volume tenfold without significantly increasing team size.

It’s hard to overstate the efficiency of smart contracts. A machine learning algorithm written by a small team of brilliant engineers can underwrite millions of loans around the world. A global coffee company in Central America can use an open source asset-liability matching program to continuously hedge its commodity risk. A cleverly designed order book system can replace an entire floor of traders in midtown Manhattan. Smart contract code can make a senior lawyer work ten times more efficiently. Imagine laptops replacing skyscrapers.

The nature of work in financial services will change. Brokerage work will mean designing order book mechanisms rather than connecting traders on the phone in a busy trading floor. Underwriting work will mean brilliant teams of analyst-engineers writing algorithms and working with large language models (LLMs).

Liquid investing will mean sifting through hundreds of thousands of financial assets looking for some industry leader in Thailand whose stock should trade at twice the market cap. There will be funds dedicated to prediction markets, and these will attract the brightest minds. There will be less paperwork, more deep thinking, and financial services workers will get better at what they do best: forecasting, risk management, and capital allocation.

Let us take a brief detour to the financial reporting-industrial complex, where this process is already underway.

Many people are involved in the management of financial data in isolated server-based financial systems. A mid-sized business may have dozens of employees responsible for managing its various core systems (e.g., point-of-sale systems, enterprise resource planning, etc.). Accounting and finance teams spend hundreds of hours each quarter, integrating output data into neat spreadsheets and ensuring it matches. Bankers and financial analysts will work overtime, trying to understand the data and feed it into financial models. Financial institutions will spend months tracking every expense and expenditure for audits. Our world's financial data lives in the ruins of thousands of fragmented spreadsheets.

Internet finance solves this problem by storing financial data uniformly on cloud servers. A small team of data scientists only needs to build a financial reporting structure for the raw data stream once. As the business grows, they only need to spend a few hours a month maintaining the reporting code, and that's it. We have already seen the prototype of this system, and data providers like Dune, Token Terminal, and Artemis are making it happen. These data sites have covered the entire subdivision of the Internet finance system with a very small team size.

I myself have benefited from unified on-chain data. I used to spend hundreds of hours building spreadsheet models of industrial transactions. This process required a small team and the result was a static spreadsheet model that only we could manipulate and update, and each update took tens of hours. Now, we only need a few hours to build active, live models for on-chain businesses that update automatically. We used to spend months doing audit work. Now, we run an on-chain fund and basically just need to send a few wallet addresses and answer a few questions. The time and energy saved is really exponential.

5. Internet financial systems will promote faster GDP growth

Joseph Schumpeter argued that more complex financial systems lead to faster economic growth, and in the nearly 100 years since he made the point, countless economics papers have validated his assertion with empirical data. Specific estimates vary, but doubling the depth of a financial system typically leads to 50 to 100 basis points of annual economic growth over many years.

It is not difficult to understand why GDP growth would be faster in the framework of an Internet financial system. Capital can flow across borders to the best opportunities without being hindered by local banking oligopolies. Net interest margins will narrow, thereby reducing real interest rates in emerging markets. The selection of high-quality assets provided by the Internet makes it easier for people in emerging markets to save and invest.

Stronger protection of property rights directly drives GDP growth. Our financial services workers can spend more time on high-value forecasting, capital allocation, and risk management. Innovative products like futarchy and prediction markets will lead to higher-quality information and capital allocation. There will be countless innovations to help companies better access capital and manage risk.

Famous map of North and South Korea at night showing the importance of property rights and inclusive economic institutions

I believe an additional 75 basis points of GDP growth is entirely possible. That would mean $15 trillion in additional GDP over 20 years. That’s the equivalent of adding the entire economies of the United Kingdom, Germany, France, Russia, Italy, Brazil, Spain, and Mexico to the global economy. It’s worth a try.

I would like to take this opportunity to make a brief pitch to entrepreneurs and financiers who are ready to transform into Internet finance. I believe that your personal GDP growth rate will far exceed the additional 75 basis points per year. Entrepreneurs who commit to Internet finance and build for the long term will be richly rewarded. The global financial system is so profitable that even a 90% reduction in revenue will bring generations of results to startups. Financial services is the world's largest and most disruptive market.

A better financial system in the cloud

Internet finance is to financial markets what Gutenberg’s printing press was to books, education and civilization. Before Gutenberg’s invention, fewer than 1,000 books were printed each year in Europe, and many of the most educated scholars worked as scribes on the continent. Books were virtually unavailable to all but the wealthiest—Dante Alighieri boasted that he owned 20—and the limited supply meant that content was limited to the Bible and a few classics.

Everything changed when Gutenberg reduced the cost of printing books by more than 90%. In the 50 years after he invented the printing press, 20 million books were published, kicking off a publishing and learning revolution that is still ongoing today. It became easier to write, buy, and read books. We witnessed an explosion of literary genres and literary talent. Literacy rates rose worldwide, and now every college freshman has the opportunity to read (Aristotle's Politics).

The purpose of this article is to tell you why we are full of expectations for the Internet financial system. The two core innovations of de-licensing, unified cloud servers and smart contract code have reduced transaction costs and barriers to entry, while destroying the entrenched oligopoly system. This is a paradigm shift with far-reaching implications.

That’s why there’s so much hoopla around cryptocurrency. It’s a dream — a noble dream — and it’s achievable. The internet financial system is a hammer blow to the world’s ossified and predatory financial institutions. It’s the open bazaar that replaces them.

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