Topic: Fractional-reserve banking in Bitcoins - nothing prevents it! (Read 6204 times)

No, but you can perfectly easily exchange a piece of paper (or electronic file) that says "I, such-and-such bank, owe the bearer of this note X amount of bitcoins."  It's just a contract.  One whose value is denominated in Bitcoins.

That is all a bank note is (or used to be), a piece of paper that says, "I owe the bearer of this note X amount of gold."  Of course, now that the Federal Reserve no longer has any gold to speak of, all that a Federal Reserve Note (i.e., a US dollar) really means is "I, the Federal Reserve System, owe the holder X amount of nothing."  

You can't transact bitcoins that don't exist.

On the contrary, I think it was the government's hand in the market that caused speculative bubbles. Specifically I'm talking about subsidization of home loans through the tax code, and manipulation of money supply/interest rates that lead to a lot of people buying houses they otherwise could not have afforded. The government, if anything, failed to regulate the natural consequences of its own actions.

Well I agree, as long as the customer is fine with keeping it within the bank's system it works. I'm not sure that is what people would want though. If we're talking about borrowing BTC then I would expect to get my BTC and have it show in the BTC transaction system. Otherwise I'm really just getting a USD (or other currency) loan that is within that system.

If you're so sure it's a bubble, then perhaps you'd like to borrow a few hundred BTC from a fractional-reserve Bitcoin bank at a healthy interest rate, and use it to try to short-sell the market.   

Obviously, bitcoin does nothing to prevent banks from doing what they have always been doing.  A lot of clueless people think Bitcoin is a "libertarian solution" to life's economic woes (ironically, this last 9 years up to 2009 have been a classic example of how libertarian economic policy, e.g. deregulating everything, is a horrible idea resulting in speculative bubbles, just like bitcoin's current price is a speculative bubble).

It is a good idea, I think.  One key class of customers would be people who want to use the BTC loans to try to short-sell the Bitcoin market.  They can borrow a bank note for X bitcoins and then sell it on the market, thinking that the price of BTCs will soon go down, and they can cheaply buy enough BTCs to pay off the loan with interest.  Of course, egg on their face when the price goes up instead...  

I knew that already; I was just simplifying for expository purposes.  Anyway, it amounts to the same thing, since if 90% of a deposit gets loaned out and re-deposited at another bank, then 90% of that gets loaned out and re-deposited, and so forth, the sum of that infinite series amounts to multiplying the total money supply by a factor of 10 (just not necessarily all within one bank).

(Proof: http://www.wolframalpha.com/input/?i=sum+from+n%3D0+to+infinity+of+b*%281+-+%281%2Fm%29%29^n .  Here, b=base deposit amount, m=money supply multiplier factor.  The corresponding fractional reserve requirement is then f=1/m.  If m=10, f = 1/10 = 10%.)


That's not true.  If the bank already has an accounting system set up for tracking Bitcoin-denominated deposit accounts, those accounts themselves are just ordinary numbers in a computer.  So, if I deposit 1M BTCs, and there is only a 10% reserve requirement, there is NOTHING TO PREVENT THE BANK from simply creating a 10M BTC loan account out of thin air (since it's just a new table entry in their database), and crediting that account with 10M BTC.  This is how it's done!  

If all that the typical customer does with their loan account is use it to write checks to other banking customers (as is usually done with USD-denominated loan accounts today), the banking system never ever has to come up with the "base" BTCs that are supposedly (but not really) backing all those account balances.  The bank is then counting on the fact that it is very unlikely that their many different loan recipients and depositors will withdraw more than 10% their entire account balances in "cash" (actual BTC) form at any given time.  The rest is withdrawn and transacted in the form of checks, or notes issued by the bank (cashier's checks).

This would be no different from the situation today, with the base currency of physical coins and bills.  If all of a bank's loan account holders simultaneously demanded a withdrawal of their loan amounts in physical currency, the bank would probably not actually have that much physical cash on hand (since only 10% of that amount was deposited), and there would be an uncomfortable delay while it procured them through inter-bank loans and so forth.  And if every customer in the whole banking system tried to withdraw all of their balances in cash simultaneously, it would be far more than there is physical currency in existence, the whole system would collapse.

Here's how a bitcoin bank that takes actual bitcoin deposits and loans out actual bitcoins might work:

The bank offers to the depositor:

- Security for his bitcoins. The bank takes extreme measures to store the bitcoins in multiple forms, offline, heavily encrypted and insured in its vaults
- An easy, secure web interface to make and accept payments
- Perhaps a modest interest rate. But the above features may be enough to entice people to make deposits and keep their money in the bank.
- 50-99% reserve.... really depends on what the market will bear, but definitely greater than the 10% that is required now, I suspect.

Then, a certain percentage of bitcoins goes out in the form of commercial and consumer loans. Voila! Free market fractional reserve banking. Anyone want to start a business with me?

Yes. Its very important to understand that fractional reserve with a central bank (or similar regulation) and fractional reserve without a central bank (free banking) are completely different monetary systems. People tend to talk about fractional reserve in general without taking into consideration if there is a central bank or not, and that leads to a lot fo confusion.

Well, yes. I think banks could hold some Bitcoins in reserve and loan out a portion and perhaps some insurance arrangement could protect them from a run on the funds. They would likely only be able to loan out maybe 50% or so.

But banks are quite used to loaning out a lot more than they ever got on deposit and I don't think they'd be interested in the paltry returns they'd suddenly be faced with being limited to just what they had on deposit. With a reserve ratio of 3% they're used to loaning out 30 times more than they hold on deposit.

OK so clearly the traditional kind of fractional reserve banking is impossible then. But the type described earlier in the thread is.

OP doesn't understand how Fractional Reserve operates and I don't know if other posters here do either. It doesn't mean they only have to keep some of their deposits on reserve - it means they only have to keep a fraction of their loans on reserve.

If they have 1 million in deposits then they keep that as the fraction of how much they can loan out. They can typically loan out 10 x 1 million = 10 million. That other 9 million they "create" as debt. This is where the real profit power if. They can make interest on about 10 x what they have had on deposit.

When you give them your money they turn around and loan out more than you gave them and make interest on all of it.

Since they can create NEW money they can loan more than on reserve. With bit coins they cannot create new money and that is the SIGNIFICANT difference between the two. They can hold some deposits and loan out some but they will never be able to leverage YOUR money into BIGGER PROFITS.

Please, if you do not believe me or don not understand then read more and learn how fractional reserve fiat currency works. It's NOT what you think because no one ever taught this in school - they don't want you to know.

The only way for price inflation not to happen is for Bernanke to remove the liquidity from the banks. And the Fed is signaling already QE3 (which will be different form QE1 and QE2, it will be similar to the Operation Twist from the 60's and probably wont be called QE3 but its still money printing to buy government debt). The Fed really can not remove the liquidity from the banks, the only thing it can do is to control the rate at which that liquidity enters the market. That is why I have been predicting stagflation but not hyper-inflation.

I agree with you. But my confidence that this is so is not particularly high.

Yes, I agree.


What? There was massive inflation due to the monetary expansion of the Fed to pay for IWW. Scratch that, I read the two wars and though you were talking about IWW and IIWW.

In the present moment there already is price inflation. The thing is that the credit crunch has produced a contraction of the debt producing deflationary preasures that have countered the inflationary preasures. But the credit is leveling so the deflationary preasures are fading, and the price inflation is starting to signal what is about to come. Monetary events are very slow. They can take years to develop.

Some people still trust that Bernanke will be able to remove all the liquidity from the banks "when the time comes". But I have written articles (not en english, sorry) showing how Bernanke can not remove the liquidity, just delay when it appears in the market (basically through playing with the interest it pays on excess reserves).

That's what everyone thought. But then we borrowed money to finance two wars, had a global economic collapse, and borrowed money to "stimulate" the economy and ... no inflation. Our understanding of those mechanics is wrong somewhere. (Not to say that really bad things won't happen. Of course they will. But a lot of them will be deflationary.)

Yup, however it just makes the more system unstable if a crisis occurs. If there is ever a very large bank run then FDIC will go insolvent and the fed will have to back up the deposits. If that were to happen there would be massive increase in money supply. By the time you got your money it would be worth nothing.

The insurance is only good until you go to collect it.

This is a incentive to not have very extreme fractional reserve banking. And that is what happened when banking was not regulated. Because banks were afraid of bank runs they kept a higher ratio, the were more prudent. Now, with regulations, they are protected from bank runs (specially because of central banking and FDIC) so they can go as low as the regulators allow them, which for example in Europe is 2% and in the USA a bit higher. The government regulations have taken the control away from the costumers. Bernanke at some point said that he wanted to change the regulations and regulate the rate to 0%. Imagine that...

Banks runs are actually not particularly hard to make much less harmful. The methods needed have been well worked out.

Basically, the bank issues notes and accounts that are payable on demand except if the bank declares an emergency (which it would do if there was a run). If the bank declares an emergency, they can pay you in notes instead of currency. The notes have a higher interest rate and are backed by loans and capital that the bank has. The only way you don't get paid is if there's a run on the bank, the bank doesn't have enough reserve, and a lot of its loans go bad. Of course that can happen, and if you're worried enough about it, you don't have to use fractional reserve banks.

The bank has to rig it so that the notes it issues in an emergency have a net present value, adjusted for risk, that's roughly equal to the value of the cash people want to withdraw. That way, people who need cash now can sell their notes, but there's not much incentive to continue the run. (Because you'll still be at some risk, and you won't get much cash today.)

If the bank declares an emergency just to save a few bucks, they won't actually make very much money, and their reputation will be ruined.