Facilitating the exchange process

The system of money has changed dramatically over the years, moving from physical forms of money to digital forms of money. Examples of digital forms of money include fiat currencies and cryptocurrencies. Digital money has introduced third parties into the exchange process that act as facilitators.

Physical exchange

Historically using money has involved a physical exchange process. Physical forms of money were exchanged for goods and services. Gold, silver, sea shells, salt, coins and banknotes are all examples of physical forms of money.

Consumers would decide when they need a good or service. They would then travel to the provider of that good or service and negotiate an exchange. Once a deal had been struck the consumer would exchange their physical money for the good or service.

The consumer would often need to travel to the provider of the good or service to facilitate the exchange. Beyond the costs of the two parties meeting, there would be no further costs to complete the exchange. For example, Alice could have $2 in physical banknotes and she might want to buy bread from Bob, which he is selling for $2. Alice and Bob are able to complete that exchange process without any third party involvement and without any additional fees or costs. Ignoring taxes, Bob wouldn’t need to pay anyone to facilitate the exchange process.

Digital exchange with fiat currencies

The introduction of digital money completely changed the system of money and how the exchange process is executed.

Let’s continue with the previous example, but now let's say that Alice has $2 on a debit card and Bob has a card reader that accepts digital payments. The exchange process has now fundamentally changed. Now, when Alice pays Bob she is now reliant on her bank, a third party, to facilitate the exchange process. The transaction information needs to be stored on a ledger by both the banks that Alice and Bob are using.

It is common that Alice wouldn’t pay any fee for the exchange to be facilitated. Banks commonly benefit from a system called fractional reserve banking, where they are able to lend out more money than what people have deposited into the bank. Banks generate income from the interest they receive from facilitating loans to different individuals. Banks will often require individuals to complete a know your customer (KYC) process so that they can comply with local regulations and provide their banking services to each individual.

For businesses, it is more common that they might pay some fee for using the banking service, whether that’s a percentage based fee on every transaction or some monthly banking fee. This fee pays for the online banking service. The business can use their account to receive, send and store money.

In a digital fiat monetary system, banks have a lot of influence and power over both consumers and businesses that rely on those services. Banks can deny anyone access to their services if they identify a risk or reason to not accept them as a customer.

When a fee is charged for completing an exchange, it is commonly in the same currency that was used for payment. For instance, Bob might accept digital payments and his bank might take a 1% fee for each transaction they facilitate. If Alice pays Bob $2 of digital fiat money, the bank might take a small fee amount in dollars. In this case, at 1% the fee would be 2 cents.

Digital exchange with Web3 networks

Cryptocurrencies represent a new approach for the system of money. Similar to how digital forms of fiat money have completely changed the system of money, Web3 networks will also have a profound impact on changing the system of money. Web3 networks will have an influence on how money gets created, governed and used.

An important distinction that can be made between digital fiat currency systems and cryptocurrencies is around what money is being used as the medium of exchange and what money is used to facilitate the exchange process.

In fiat systems these are commonly the same thing. Alice pays Bob $2 and the bank takes a small fee in dollars as well to facilitate the exchange.

In Web3 networks, tokens can be created within these networks that represent anything, such as a physical or digital asset. Tokens could also represent a digital form of money. They could also represent a physical object like a house, car or mobile phone. Web3 networks are permissionless, meaning anyone could create or use any token based asset to exchange value.

This system of money is fundamentally different in a Web3 network than the fiat banking system. In the fiat system, people cannot create new assets using their banking service. They also can’t send token based assets to other people. Banking services might support other fiat currencies from different countries but apart from this, the user will commonly be using the national currency.

In Web3 ecosystems the medium of exchange is anything that the user wants to use to exchange value to another person that they are willing to accept. Web3 networks drastically increase the number of possibilities that people have when deciding what to use as a medium of exchange. Each person could use one or multiple forms of money.

Web3 networks cut out the middlemen that have previously facilitated the exchange process. Instead of the banking system it is now a group of node operators that each run software that operates the network. Web3 node operators are not able to block peoples transactions unless a majority of them decided to do this. Due to the decentralisation of the node operators, Web3 networks help to remove the power structures that previously existed in the fiat banking system, where banks could deny people access from using banking services if they wanted to.