Topic: Fractional-reserve banking in Bitcoins - nothing prevents it! (Read 6187 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.

There is a huge incentive to not have fractional reserve banking and here it is:

http://www.youtube.com/watch?v=qu2uJWSZkck

Yes... For example, if I deposit bitcoins into an account at mybitcoin.com, and take a screenshot showing my account balance, you could call that a "bitcoin backed note" of sorts.  (It would be better, though, if the site gave you a formal, digitally-signed certificate showing your balance.)

It would be ok if it was just a business model, but then it would be ok to compete with them on a large scale. I'm almost certain that when Bitcoin or any cryptocurrency gets popular enough, the central bank system will try to make laws against it, not because there's anything wrong with cryptocurrencies, but because their "business model" is really a dictatorship. We don't need to make laws against Fractional Reserve because the right to compete is enough.

It's got nothing to do with fractional reserve banking. It's just a business model. Banks operating a fractional reserve just happen to have a monopoly in most countries. Examine the nature of that monopoly. Is it backed my violence?

Google "Von NotHaus" for the answer.

http://en.wikipedia.org/wiki/Fractional-reserve_banking

It makes the rich get richer and the poor get poorer. When the poor lack food or other things, they make a plan of how to get it from the rich people. When the rich use supply and demand to determine who should get food and who shouldn't, they make another plan, which is to fight for survival, and others join them. Food is one of many things they fight for, and its not always things they need, but it is mostly caused by "the rich get richer and the poor get poorer" which is mostly caused by the Fractional Reserve system and Patents, but Patents are a different problem.

In a Fractional Reserve system, terrorism (a type of war) and other wars are inevitable and in increasing amounts over time. As such wars increase, Patriot Acts and other reductions of freedom and increases of military spending will happen. Reacting to that, terrorism and other wars will increase. Its a cycle of conflicts escalating until World War 3.

Therefore we either get rid of the Fractional Reserve system or World War 3 will happen.

The anonymous part has advantages and disadvantages, but just about the economic part, an unlimited grid of Bitcoin currencies, each with their own network, each designed with their own economic equations, is an example of a better system than Fractional Reserve, because economic equations would evolve and compete the same way products evolve and compete today, and whatever equations work best would be used by more people, more invested in them.

Someone could probably try this on a small scale right now if they could figure out a way to issue some kind of BTC-backed notes.  Physical notes are obvious enough, but the electronic format of such a thing would require some amount of cleverness...

Yes, its not really viable at this point. But in the future it will probably happen (Im pretty sure it will happen).

Getting back on topic, I can't see banks that do nothing but take in bitcoins and loan than out again being viable.  How do you secure a loan denominated in bitcoins?  If I loan them out and the value doubles or triples the borrowers would probably never be able to pay the loan back.  It seems like it could possibly work if you were only lending capital to fund bitcoin businesses who would thrive if the value jumped, but I can't see how it would really work.

Two different people consider this trolling. Sorry, good enough for me!
I apologize, and I am out of this subject 

If you trust the bank enough you could have an anonymous account just controlled by a private key. IF you trust the bank enough (big IF, but there are some examples in reality).


Stop trolling. That you engage in some contract with the bank does not mean their notes become legal tender. IT just mean that you accept them, not everyone else. Legal tender means that the bank notes are forced upon everybody.

Uncle Vinnie, thank you for not calling me retarded 

Not if you don't want to. Others might.

So we would all need to accept "their books" as legal tender  

*shrug*

I doubt it would work in an anonymous setting. Banking depends on trust.

I'm assuming the "men with guns" means the government. Societies find all sorts of interesting solutions for contract enforcement, and settling peacefully is usually cheaper than going to war.

The deposit (transfer of possession of the 100BTC) would be reflected in two places; in their books and in the block chain. According to the block chain, the bank owns the 100BTC. But according to the contract between the depositor and the bank, the depositor owns the 100BTC but consents to the bank lending all or a fraction of it out.

So, vinnie, how would this work in an anonymous setting, and without "men with guns"?
Just trolling...

Adam, thank you for your opinion on my IQ!
Retarded as I am, please explain how the bank (which one?) can "deposit" BTC100 in the block chain if said bank does not own BTC 100 to clear the transaction.

Thank you in advance for your explanation!

In addition to what Adam said, the bank would likely be issuing a bitcoin backed note or secondary digital currency. So they would either issue the loan in the form of BTC and pay their original depositor his withdrawals in bitcoin backed notes, or issue the loan in the form of bitcoin backed notes and pay the original depositor in his original BTC.

Are you trolling or just retarded? 

• I have 100 BTC
• I deposit this with the bank, now the bank has it
• The bank takes these BTC and loans them to someone else so now this third party has them

Would you care to explain how a bitcoin bank can lend a hundred bitcoins it does not have?
Some details on how the block chain might look would also help...

I apologize if it's nonsense to you.

You had to post nonsense four times in a row in the same thread?  Of course fractional reserve currency works for bitcoins.  I deposit 100 BTC in bitcoin bank.  My balance in the bank will show up as 100 BTC, but those specific coins can be lent to someone else.  No coins were created in this transaction.  I have a claim for 100 BTCs with the bank, but no actual bitcoins, because they were lent to someone else.

Simply because there's no bank helped by "men with guns" to enforce debt obligations denominated in BTC (yet  )
However, you may have noticed that many users support government regulation of Bitcoin, so time may prove you right 

Unless the pseudonymous character of Bitcoin si completely destroyed, it would be impossible to have fractional reserve 2.0 happen here 

Let me clarify. You (Alice) can write a check (you got from your credit card company) tomorrow for $100 and give it to your buddy (Bob) who can deposit it and later use the money to pay his mortgage.
No $100 dollar bill has changed hads from Alice to Bob to mortgage servicing company.

Bitcoin scenario:
Alice wants to send 100 BTC to Bob and Bob wants to pay his mortgage.
Alice HAS to have the 100BTC she wants to send to Bob. Unless the 100BTC are in her wallet (well, this is a complicated conversation) she cannot send it to Bob, who cannot pay his mortgage with it.
There are no bitcoins made of thin air like the fictitious USD printed by the banks...

Fractional reserve banking is impossible within the Bitcoin system. Please read the software manual again 
Unlike fiat currencies, one cannot "deposit" a bitcoin that does not exist 

The thing that 'stops' fractional reserve backing is called 'going out of business'. The problem is that banks who would fail are magically saved with our money instead of failing and allowing more responsible banks to win customers. It's to the point now that you have to participate in the way overboard fractional reserve plus insurance scheme to get permission to operate at all.

Now to be clear, with BItcoin, you can have unbacked balances at a Bitcoin bank denominated in Bitcoin, but you can't actually have the extra Bitcoins in your client at the same time like you can in a dollar bank. The base money is strictly limited with Bitcoin, but not with the dollar. If dollar banks have to give people their dollars simultaneously they are printed.

I'd love to see fractional reserve banking.  As long as people understand the REAL risk associated with default, bank runs, etc., they will charge absurd interest rates to the banks to make deposits.  To avoid all risk, you should just hang onto your BTC yourself.  The banks, in turn, to pay your deposit interest must charge extremely high interest rates to borrowers, keep lots of capital on hand, etc.  In other words, both lender and borrower would be more cautious.  And no TBTF.  If there's a wave of defaults and a bank run, everyone involved loses and the money supply returns to its former level.  Mattress stuffers win big.

Actually there is lots that prevents fractional reserve banking. Its called not putting all your money in the bitcoin bank and no FDIC. The end result is that if too many people pull their money from the bitcoin bank then you have an old fashioned bank run. These bank runs will severely limit the size and trust of any fractional reserve bitcoin banks.

There is nothing wrong with fractional reserve banking. The problem is when you have fractional resrve banking + central bank (or similar regulations). Then you get all the problems. But fractional reserve banking alone is not a problem, and its even positive because it helps the allocation of capital and stabilicies the swings due to changes in the demand for money.

I recommend this blog as an starting point to learn why free banking (fractional reserve WITHOUT a central bank) is positive: http://www.freebanking.org/ Also, this article by George Selgin: http://www.independent.org/publications/tir/article.asp?a=774


No. It depends on the system. Under a free banking system (fractional reserve WITHOUT a central bank) the banks tend to only accept gold (or in this case bitcoins) as base money, they dont accept notes of other banks.

Accepting notes of other banks as base money only happens when there are regulations, like we have now, that protect the banks (FDIC, central banking) and allow them to overexpand the supply of money, creating debt and inflation.


Actually, history shows that free banking system (fractional reserve without a central bank) are remarkably stable and wihtout too many bank runs. The banks know that there is no one to protect them and are forced to behave because of fear of going bankrupt. Fear and greed always balancing each other. If you take the fear away with a central bank, fdic, and other regulations then banks start to misbehave and you have things like the 2008 collapse you mentioned.


Fractional reserve alone is not inflationary. Once banks reach the zone of equilibrium they mantain the reserve ratio in a range, thus the money supply remains stable, only reacting to changes to the demand for money (this is a positive effect of fractional reserve).

Lots of insightful answers, thanks!!

Indeed.  That's the other main point.  There is no way to save such an institution when it fails. It might work a few times, but people will learn.

You can start a fractional reserve or even a zero-capital-reserve bank anytime. In secondlife there used to be many zero-capital-reserve banks, when they "failed" depositors lost their money (and their 30-70% annual interest gains) but the currency didn't inflate any more nor any less due to those failures.

The biggest one was a zero-reserve bank, he started it without ANY capital at all.
http://www.wired.com/gaming/virtualworlds/news/2007/08/virtual_bank

The systemic risk that got created was that other people copied his idea and started their "fractional or zero reserve-banks", part of the problem was they put their depositors money in the Ginko Bank or other similar banks to earn interest. Then when a few of them collapsed, the rest collapsed. However there was noone printing massive amounts of new money to rescue depositors, therefore no inflation was caused due to these "failures".

Yes, you can have Fractional-reserve banking in Bitcoins.  I don't see it happening in the near future, though.

They can't inflate the base supply like they can with fiat currencies.  Not perfect, but much better.

So, I've noticed that many people like to think of Bitcoins as a solution to the way that central banks today can inflate the money supply of fiat currencies...

However, it seems to me that the powers-that-be could use the very same methods to effectively inflate Bitcoins, as follows...

Suppose that someday, Bitcoins become widely accepted, enough that most commercial banks start offering their customers demand-deposit accounts denominated in Bitcoins.  (Just as with paper money, the value-add could be, "We'll keep your coins safe from theft in a secure electronic vault, and plus you'll earn interest on them.")

However, just like with paper dollars and coins today, banks would not necessarily have to hold onto enough actual Bitcoins to pay out on 100% of their deposit accounts - just a percentage of them, like 10%.  The rest could be loaned back out.

This is how the banking system (all the way up to the Federal Reserve) works today, and by doing so, it effectively increases the money supply - if a bank has X amount of deposits, they keep X/10 amount in their vaults, and loan out the other 90%.  Both the depositor and the loan recipient think they have the money - so there is (a perception at least) that there is more money than before.  (This is called fractional-reserve banking, and it is (or has been) the basis of credit-fueled economic growth, increasingly so through the hundreds of years since its invention by the Medicis...)

Anyway, as the loaned amounts are re-deposited at other banks, the cycle repeats itself, and as a result, the effective money supply can increase many-fold above and beyond the supply of "base" physical (or in this case, virtual) currency.  This higher-order money supply would then include not only actual Bitcoins, but Bitcoin-denominated demand-deposit accounts and loan accounts at banks -

Obviously, such a system would be vulnerable to a "run on the bank", and institutions like FDIC could insure individual banks against such eventualities... while failing to prevent systemic risks (such as the near-collapse of the banking system that happened in 2008).

But, I see no reason why this same entire edifice of fractional-reserve banking, with all its inherent risks, could not or would not be rebuilt on a foundation of Bitcoins, assuming they became popular.

So in other words, this community will have put in all this huge effort to build up a new "inflation-proof" currency, only to find that it still ends up being prone to inflation as a result of central bank/government manipulation anyway, as the banking system (with its shady accounting practices) multiplies the effective money supply way out of proportion to the underlying asset...  (At least by up to about a factor of F, if the reserve requirement is 1/F.)

Any thoughts?