Hi Fintech futurists --

This week, we cover these ideas:

• The nature of digital identity, and the difference between a representation at some moment of time vs. a record of your being

• The launch of the DeFi Passport by Arcx and how it can be useful for underwriting

• The European Digital Wallet, and the implication of such a development for CBDCs and government services

• China’s CBDC, Sweden’s BankID, and other existential crises

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Cover Art this Week

Long Take

In WandaVision, Marvel’s most experimental take on story telling yet, we have a scene between two different instantiations of the android character Vision. One is the husk body of the original — no ghost in the shell, but moving and talking nonetheless. The other is a hallucination, a memory turned temporarily real by the magical Wanda. The two Visions have a philosophical exchange about who exists and how, and whether one can remain oneself at all.

It’s a pretty good take on pop philosophy, wrapped into the parable of the Ship of Theseus.

There exists a ship owned by Theseus, who was a brave warrior. Theseus’ ship was decided to be kept and maintained by the Greeks as a memorial of his life. However, over time the parts of the ship would decay and would require replacement. After a long time, every single part of the original ship of Theseus had been replaced by new parts. The question we need to answer is: Is this ship still the ship of Theseus?

There are different ways to propose solutions to this problem. One is to just point out that a ship — at least the concept used in language — is nothing but a “model”, a mental shortcut for some functional instrument, and therefore disconnected from a true reality we attempt to describe (and that perhaps no such thing as reality is true). Whichever instrument is owned and used by its owner is the true one. Another is to say that the object has a dimensionality of time, and therefore both resulting ships are the same as the first ship; this hydra object is simultaneous with its origin. But so is every atom of the universe in relation to the Big Bang.

Things get a bit wackier when we realize that our own bodies are a Ship of Theseus. Most of our parts are in a constant part of degeneration and regeneration according to the programming in our DNA.

A purist may insist that one is just the clump of neurons that lasts a lifetime and creates our cognitive associations. By analogy, perhaps what is profound is the set of judgments we persist and make over time. Our self is not that the stamp of existence at some particular moment of time, but rather the streams of social effect that we cause in the world, and under which we bend ourselves.

Identity in DeFi

We start with philosophy to contextualize a couple of separate threads that are worth tracing to a core question — what is Identity?

We ask this question in response to the following symptoms. Crypto and decentralized finance seems to be re-inventing credit scores and reputation rankings from scratch. Arcx is launching a “DeFi passport, ” which will look at the repayment history of particular addresses in order to generate scores of 0 to 1,000 on those addresses. In turn, addresses with higher scores may have access to higher interest-bearing investment opportunities and lower collateral ratios, and be anchored to “real people”. How scandalous!

If you are a DeFi protocol offering investment opportunities, it is likely you would like well-behaved investors rather than, let’s say, financial murder bots.

But you know, this isn’t like, a surprise. The traditional economy has credit scores composed of repayment variables as well.

Of course we like to finger-wag at Experian and the traditional systems for how inflexible and insecure they are. The data model for the credit agencies, which is “just sort of host all our data behind a default server password sometimes”, is what we are justifiably salty about when they lose all our data to hackers. The algorithm for deciding trust-worthiness is another thing entirely.

Those algorithms have their own problems. Over the last 5 to 10 years, the human underwriters that would crunch the numbers to get you to a credit score have been replaced by large clusters of machine learning AI. The human judgment has been replaced by machine judgment — and this is largely a good thing. Instead of making mistakes or loosening underwriting standards, we ask impartial robots to do the work for us. Or do we?

It turns out, we just program our racism and classism into the machine intelligence by selecting data that reflects the current distribution outcomes of society. In turn, this calcifies outcomes into decision making models. One clear example is Amazon discontinuing a certain AI-powered recruiting tool because it voted down candidates with a female name, since male names were more likely statistically to already be high-powered tech workers.

However, as our mathematical engines mature, and our social aspirations become more explicit in software, it is possible that access to money will be fairly moderated by machines.

In today’s crypto world, that access is not moderated at all — it is fair in the Lockean sense of raw, tribal competition and caveat emptor. But such equilibria do not persist if they are to be successful. As we move from one-time game theoretical competitions in every crypto bull market, to long-term adoption of crypto assets as the chassis of global financial services, the edges will soften. The way to deal with a Prisoner’s Dilemma is to signal that you are playing it honestly, and that you are playing it *forever*.

This is Identity.

It is that flow of activity over time that signals to the rest of the super-organism what you are really doing, what kind of “gear” you have announced yourself to be in the machine, and how you are tracking on that promise. If you want to go deeper on this topic, we strongly recommend our conversation with Michael Cena of the Ceramic Network here. Whereas Michael started working on the identity problem by trying to add labels to people, where he ended up is creating a protocol that tracks historic software activity and interactions between actors. In thinking about the Ship of Theseus, this is the solution that says — your identity is your journey through the river of time itself, and not any particular stop you make along the way.

This is Reputation.

Identity in Finance

We’ve gotten pretty heady over here, talking about computational time and gesticulating about game theory. But there are some important overlaps with money and payments.

Some payments industry insiders would say that payments is not a difficult problem — moving money is trivial. Rather, what is hard is the identity problem between participants. Thus arises KYC/AML, FATF, and a variety of other conceptual frameworks meant to prevent harm in the real world by identifying and isolating the individuals who would cause that harm. To stop them, you have to know them. And it is this motion that is responsible for crypto-tracking company Chainalysis being worth over $2 billion, and KYC/AML regtech providers like ComplyAdvantage generating enormous machine-powered identity databases across the web. Reputation accrues from the lack of fraud over time.

Thereafter, we have to minimize the presence of the identity police for the benefit of a smooth onboarding of customers to maximize our conversion rates for revenue generation. In this balance, lies the whole dramedy of financial services.

It’s not like you can really trust Google or Facebook with our identity either. Maybe they care less explicitly about facilitating our money flows, and therefore are less likely to encourage lots of bad money flows. But rather, they eat identity for breakfast — and sell it to political mind control groups and various government agencies.

You might have thought the Internet was pseudonymous in 1993, like blockchains are today. You might have thought that your media and attention-spending activities were your own, protected by a veil of random text characters.

Edward Snowden showed us this wasn’t exactly the case. The US government knew very well exactly who you were. That, and it knew how to make embarrassing PowerPoint slides.

And big tech didn’t need to reveal your information in order to target your demographic. We are not for sale to the highest bidder, but we are for wholesale.

So to some extent, we can try to argue that identity and reputation should be public goods, provided by an altruistically-motivated body in order to benefit its constituents. We can be skeptical about such an argument, but don’t have to be. Governments have always handed out passports and other signals of national or social belonging. More often than not, they have done that as part of a social contract — yes, to tax the passport holder, but also to render upon them the social safety net of modern economies.

If we look in this idealistic way at the recent Central Bank Digital Currency developments, things can click together. A CBDC wallet, which is in essence an identity wrapped into government fiat money, is already installed across the major banks in China. The recent flexing of CCP power against the financial technology companies Ant Financial / Alipay and Tencent / WeChat Pay by pushing them into a regulated financial holding company structure signals the integration of the digital yuan into their footprints — which numbers around a billion users.

The European Union is now trying to introduce a similar concept across the several states, calling it a digital wallet for identity, payments, and passwords. It would allow holders to interact with local government services, as well as to be used as a payments authenticator more broadly. And super obviously, it could house the Euro CBDC. We are fans of the concept, and are charmed by its European sentiments.

The private sector has routinely shrugged off government initiatives in Europe that were meant to tackle some sort of market imperfection. Look at PSD2 and open banking, which was meant to lower the cost of money movement, to realize that the card networks (i.e., Visa and Mastercard) continue unimpeded. GDPR has polluted websites with checkboxes for data storage consent, but not much more in terms of user experience. It is hard, for Americans at least, to imagine the European wallet succeeding. But perhaps the definition of success is not right.

The Nordic countries have had a marriage between identity, banking, and digital cash that has worked. This is leading to Sweden being one of the first countries to pursue the CBDC path publicly with experiments being done in the open.

Sweden’s Bank-ID project, which is a long-standing authentication partnership between the handful of large banks in the country, has nearly 94% adoption and is integrated into the country’s identity system.

For scale, Bank-Id has 6.5 million users. That’s less than the user base of Robinhood or Chime, and about 100 times smaller than Ant Financial. So perhaps, it is also easier to coordinate compliance.

Another geography to watch for similar developments is India, with its Aadhaar identity program underpinning government and financial services. Our previous discussion of the topic is here, noting that mobile phone purchase itself requires an identity disclosure. With India’s ambivalence towards non-government crypto assets, we expect an Aadhaar-anchored CBDC to be imminent in the medium term.

Final Takeaways

Emerging crypto and fintech networks would do well to learn the lessons of the past. Social systems require evidence of participation, a map to how some particular person has behaved across various circumstances. This evidence is not collected for a dubious purpose, generally, though it is often abused. Rather, it is collected for decision making about a proposed transaction or interaction within a social, multi-party context. When a function needs to know its counterparty, the river of history has to be compressed into a reputation score, which then gates access or permits it.

We may have issues with how the gating is done, and the distributional outcomes thereof in the traditional banked economy. We may dislike the robots that do it, or the owners that own them. We may think that risk is wrongly measured, and that a lack of data merely implies a lack of power.

Fintechs have regenerated credit ratings and access to money through micro-lending and social reputation scores. Consider the growth of this approach in Africa, building on top of novel information sources like mobile money streams, call patterns, and other correlated data sets.

Community vouching is another time tested tradition, and can well be applied to crypto networks (if one can restrain offchain collusion).

In all cases, the scores are mere models of reality. They are compressions of a broad set of interactions, squeezed into a format acceptable to a calculator for a moment in time. Remember to focus not just on the format, but on what it represents and on the future that it unlocks for the ship traveling turbulent waters.

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