Topic: Is Fractional Reserve banking possible with Bitcoin? (Read 5956 times)

I think this will be an impossible feat to achieve given the fact that the price of bitcoin is constantly fluctuating. Let say a "bitcoin bank" would get a reserve of the total supply of bitcoins in the world. If the prices go down drastically, that reserve would have no value at all. Banks would then have to close down since there is no money that would be circulated.

No, fractional reserve banking is not possible with bitcoin. I am not clear why anyone thinks it is possible.

An example of fractional reserve banking:
Bob makes a $10000 deposit and is the only customer at a bank.
The bank lends out $9000 to Alice.
Bob returns and asks for the $10000 back. The bank gives him the full $10000.

At this point in time there is $190 in circulation from an initial total of $100. Yes, the $90 to Alice is a loan and needs to be repaid. But at this point in time there is still $190 in circulation.

With bitcoin:
Bob makes a 1 bitcoin deposit and is the only customer at a bank.
The bank lends out 0.9 bitcoins to Alice.
Bob returns and asks for the 1 bitcoin back. The bank can only give him 0.1 bitcoin back.

Whether or not Bob thinks (before returning to the bank) that he has 1 bitcoin deposited, and what the bank shows on its balance is immaterial. The amount of money in circulation never exceeds 1 bitcoin. This is a very different situation to what is described above.

Persons are referring to the latter case as an example of fractional reserve banking with bitcoin, which it is not.

Yes it is possible and likely.  However Bitcoin has some properties which make it more resilient to a fractional reserve system than other forms of money.  I will try to explain below:

The core characteristic of the traditional banking system, is banks’ ability to expand the level of credit in the economy, by creating new loans and increasing deposits. This is a core driver of modern economies and a key reason for financial regulation. There is a risk banks lend out too much money in a credit boom and thus a safety net may be required to bail out the banks. In the context of Bitcoin, it is important to understand the reason banks have the ability to expand credit, which is because users treat bank deposits in the same way as cash, enabling banks to expand loans and therefore deposits, at will. People treat banks deposits this way for perfectly reasonable and logical reasons, in fact banks deposits have some significant advantages over cash, which I will try to explain below. Many of these advantages either don't apply or only partially apply in Bitcoin. There is no conspiracy or master manipulation by the financial elites; it’s very much a product of the nature and characteristics of most forms of money that bank deposits are simply better than cash.

Bitcoin has at least five properties (listed below) which provide some level of natural resilience against credit expansion, which traditional money does not have. This does not mean there cannot be a few dominant Bitcoin banking institutions engaging in credit expansion, it merely means Bitcoin may be more resilient to this than more traditional forms of money.

1. Security

Keeping money on deposits in financial institutions, increases security relative to keeping large physical cash balances at home

Bitcoin can allow a high level of security, whilst the user maintains direct control of the money without using third party financial intermediaries

2. Convenience

Using the banking system, it is possible to send money effectively over the internet or by phone, for example. If physical cash is used, then a slow, inefficient, insecure physical transfer must take place

Bitcoin can allow users to efficiently transmit money over the internet or even phone, whilst maintaining direct control of the money and without using third party financial intermediaries

3. Easy to exit

In the traditional banking system, withdrawing physical cash from a financial institution is a long administrative process which takes time

Bitcoin can allow users to withdraw money from deposit taking institutions quickly, which may encourage banks to ensure they have adequate money in reserve at all times

4. Auditability

Traditional banks offer the ability to track and monitor all transactions, which can help prevent fraud and improve accountability. This is important to many businesses and physical cash cannot offer this

Bitcoin’s blockchain can allow users to effectively audit all transactions, without using third party financial intermediaries

5. "Hybrid banking" models (perhaps the most significant)

In traditional banking models there are only two fundamental choices, 1. Physical cash which provides full user control of the money, and 2. Money on deposit at a financial institution

Bitcoin allows a wider spectrum of deposit and security models, resulting in a more complex credit expansionary dynamic

Please see some examples below of "hybrid banking" models:

• Full user control of the money, where only the user holds the private key. e.g. Bitcoin Core, Blockchain.info
• 2 of 2 multi signature wallets, such that both the user and financial intermediary must sign a transaction e.g. Greenaddress.it
• 1 of 2 multi signature wallets, such that either the user or the financial intermediary must sign a transaction
• 2 of 3 multi signature wallets, such that two of the user, a hash of the users password and the financial intermediary must sign a transaction e.g. Coinbase Vault
• n of m multi signature wallets, such that…
• Hierarchical deterministic wallets, such that a root private key can generate branches of junior private keys…
• Hierarchical deterministic multisignature wallets, such that...
• Traditional banking model e.g. Circle, Coinbase

I think there is an important inflationary effect due to exchanges fractional-reserve,
I started this topic about: https://bitcointalksearch.org/topic/dataexchanges-their-way-of-using-a-fractional-reserve-and-generate-inflation-945881

Civilization (=society, collectivism, organized violence) is a ponzy scheme from the beginning. Fractional Reserve Banking is only the logical effect of it and it is as old as the Civilization.

A Ponzi scheme is evil (it is a crime in fact). Fraction Reserve Banking is just a fancy name for a Ponzi scheme.

Everything correct in your statement, except the last sentence. Collectivism with indebted people (society) is always evil and against the nature of human being. There is no individual liberty in a democracy. Individualism in a collectivist society, where you are enforced to pay protection money to the mafia (church and state) and where you are ruled and terrorised by the hypercollective and its representatives, is also against the nature of human being. Natural human being is a life in non-patriarchal, non-monogamous, self-sufficient communities, beyond the state, beyond debt, and therefore beyond business and money. Pairing families and harem families are unnatural slave constructs (famulus = house slave), originally constructed by the mafia (church and state) for the purpose of paying protection money, which began about 10'000 years ago.

Well, they could stop allowing fiat withdraws at all (which some people seem to  be convinced they do) and continue to 'print' more fiat. The only case in which they could fail to do so is if there isn't enough BTC in their system to buy... which...



...Is actually surprisingly close to happening.

I don't get the purpose for Gox to sell BTC it doesn't have. If it sells BTC it doesn't have, its just getting back some of those USD it doesn't have. And since BTC is inherently more liquid than USD, the chance of a BTC bank run is significantly greater than a USD bank run. As such it would make much more sense to just continue to "print" as much USD as possible.

People untangled it, everything is transparent: banks have been fu**ing people all over the world. Just look at the LIBOR scandal - worlds largest banks addmited that they formed a cartel, somebody sued one of them, they managed somehow to convince the court that anti-monopoly laws don't apply to Banks!
BTW, system is not fragile due to its complexity.

I'm a web developer by profession, and as I've been learning about the banking system lately, I've often been shocked at the depth of the dependencies in the system. It's a tangled mass of them, and that makes a system very fragile. That and as the post before yours points out, it's not transparent, nobody can really know what's going on.

But those are objections to the wisdom of FRB, objections I agree with. But I do now think FRB is possible with Bitcoin, if not wise.

It is not so simple, there are serious implications. After second deposit by company C the total balance in all of bank accounts is doubled! After the bank lends the money to D, there are now two persons with bank accounts with balance of 1 (BTC or USD, or whatever) and one person (D) with actual cash or coin. Now, suppose that person D burns the cash, dies and loan collateral is also destroyed or devalued. Then bank defaults and TWO persons are loosing their money from the bank (A and C). Thus, the economic effect is just as if the multiplication was real, not metaphorical, I.e. two persons are hurting because they lost a coin, even when there was only one real coin. This scenario on a large scale is the source of all economic problems today.
The core of the problem is lying to people on many levels. It starts by lying to average Joe that bank is just "keeping his money", not lending it again. There are lies for people who ask one question, then lies for people asking next question, then more lies. But if you ask too many questions, you eventually come to truth, and what was conspiracy theory a couple years ago today is known fact.

There is the promise of "multiplication" when the illusion of liquidity is given to such debt.

For example, there is absolutely 100% no problem with CDs. CDs are perfectly legit and transparent debt instruments. Same thing with bonds. These are perfectly OK and nobody is (or at least should be) complaining about them.

The problem happens when something like a CD is exchanged for something like a Money Market Fund instead. Debt instruments are inherently non-liquid, and by trying to cover up non-liquidity with liquidity you are essentially committing fraud.

Look, I have no problems with "spendable-IOUs". If someone really wants to accept a CD as a form of payment, then that's their choice. I also have no problem with a bank offering to buy back the CDs it issued itself so as to provide greater liquidity to its customers. I absolutely do have a problem with a bank issuing tons of CDs for 1BTC each, calling each of those 1BTC CDs "1BTC" rather than "1BTC CDs", and then "guaranteeing" to customers that it will pay back those CDs "whenever" with 1BTC + interest when clearly it doesn't have the funds to do so "whenever."

The first is, at the worst, potentially irresponsible borrowing/lending practices. The second (calling CDs liquid money) is actual fraud.

OP here.

Thanks everyone for all of your input. What a great forum.

For myself, I feel like I can answer the question now to my own satisfaction at least: the answer is YES it is possible.

My confusion was about the money multiplier. My sense initially was that this would require creation of new coins, and so would be impossible with BTC.

Now I see that where my confusion was. The coins don't need to be newly created Bitcoins to be "mulitplied" In EFFECT, because the coins only need to be used sequentially by different users. So the money isn't LITERALLY multiplied, but it's effect on spending is.

So person A deposits a coin, and the bank loans it to person B, who spends it on a car and gives to company C, who deposits in their bank, who loans it to person D. As far as the spending goes, it was AS THOUGH 4 coins existed, and so it's said to have been multiplied.  But as far as BTC is concerned, it's all the same coin, so there's no double spending problem.

So "multiplier" as used in the context of FRB is a metaphor only.

Wait, are we talking about opportunity cost, or value? Clearly loans have benefit to the consumer, I'm not disputing that. I have no problem with loans per se - it's when you're trying to loan something that doesn't actually exist, then I take issue. With fractional reserve, the money isn't sitting in a vault - that's the point.

Putting the morality aside, mathematically the whole thing just doesn't add up. Banks create some money, then expect interest to be paid on it. Where exactly does that interest come from? There's barely enough M0 to pay it. The whole thing has to come crashing down at some point.


Analogies do

There is no real M0, in USD.

The very first fiat USD (once the gold standard was removed) was lent to the US Gvernment by the Federal Reserve at interest rates. So, sure, you might assume that there is some M0, except all of that M0 and more must be owed back to the Federal Reserve at all times. Thus there is no real M0.

The backing for the US Dollar is the frantic search for people to repay fractions of an unpayable debt.

The economy and businesses would not be better off without banking debt because there are legitimate reasons to borrow, and a free market will sort that out. However the free market has limitations, actually, I should put that in the singular: The free market has a single limitation. And that limitation is knowledge. Given a perfectly informed populace the free market would be perfect in all regards. The only reason why fractional reserve banking can cause problems in a free market is because it is traditionally impossible to provably quantify the amount of currency in a reserve without destroying the point of the  reserve in the first place.

Bitcoin does away with this problem to some extent since the amount in reserves can be proved through signed messages originating form an address. The only problem is, of course, that there is no way of provably quantifying how much is owed. Still, its a major step forward into rationalizing the world of fractional reserve.

Unfortunately, genies, unlike banks, don't exist.


Okay, let's have a deeper look, if you wish (now I'm the genie granting wishes, here's number 1).
That measly capital ratio is not the opportunity cost, but you already know that.
The ability to "change a number in a database" in a precise, officially approved, widely accepted manner, is brought into existence by a huge apparatus of laws, regulations, technical implementations, a delicate balance of measures and countermeasures, huge networks, a gigantic organizational effort to get all theses things "just right" so that it's not easy to "change a number in a database".
That's a value in its own right, and even that's not the opportunity value.

The opportunity value comes from the fact that by granting that loan to you, you will be able to do something productive with the money. And that will be worth a lot more than the money just sitting in a bank vault, a database, a paper wallet or wherever.


You are absolutely able to do the same.
The money created while the lending is in effect can not be spent by a bank. It collapses on payback.
The only value the banks may "leech" from a loan is interest.
And so can you.

qwk, in response to your well-presented logical fallacies:

Something can have an opportunity cost, and still come from nothing. Example: a genie gives me three wishes, and with one of them I ask for £10k. Poof, wish granted. Where did that money come from? Did the genie earn it? I think not.

Likewise with a bank - you ask for a £10k loan, and poof, £10k appears in your account. Did they have that £10k to loan? Bullshit they did, they changed a number in a database. The only opportunity cost being some measly capital ratio they have to abide by.

Why is it that banks get to do this? Plenty of us have capital - I bet if we all could create money in this manner then the system would come down like a house of cards. Instead we have a slow decay, while the privileged money creators leech all the value they can.

The opportunity value is precisely what you make of it.
It's derived from time preference, and roughly opposite to opportunity cost.
It's very difficult, if not impossible to calculate, that's why we rely on the market to determine said value.
http://en.wikipedia.org/wiki/Time_preference
http://en.wikipedia.org/wiki/Opportunity_cost
For your specific mortgage, well, how much interest do you pay? That's the opportunity value as determined by the market (with some regulation, risk-management, administration, marketing costs etc. factored in).


No.


Google finds a few (tens of thousands) hits for the term "opportunity value", but admittedly, it's more a buzz today, whereas the term "opportunity cost", which describes (not exactly) the opposite, is much more common and well-defined.


I'll have to repeat myself here. Money is not created out of nothing.
Just because you don't understand how it comes into existence doesn't make it magic.
The process of money creation is well understood, there is not substantial controversy about it amongst economists.


You may find that "scheme" evil, but it made the rise of the middle classes possible at the end of the middle ages.
It powered the progress of modern society towards individual liberty and democracy.

I fail to see "evil" in that.

Theoretically, it's possible, but it would involve using bitcoin iou's as currency and not actual bitcoins on the blockchain.  I have a hard time believing there would be much interest in bitcoin iou's, but you never know.

If you loan it, you might as well loan to a bank. In fact, the likelihood of getting scammed in a loan is probably lower with banks.

Storing your bitcoins in your paper wallet and leaving them untouched may be safe, but it is certainly not the most profitable option.

Now, let's imagine a scenario. Say, in 5 years, you want to buy a house. All you got is bitcoins. Will you part from your coins in exchange for the house, or would you rather take a loan on the house and leave your coins as collateral? What if the bank even pays interest on said collateral?

I know, a lot of people will come up with the old (incorrect) argument that interest is not possible in a deflationary currency etc. pp. Well, making a false statement over and over again...
Just because something might not be sustainable over an infinite period of time does not make it impossible.


Banks are not needed. Many debtors can do some kind of "fractional reserve". If you regularly buy from different sources with a payment target of a few weeks, you can, too It is in fact illegal for most businesses, though, while it's perfectly legal for banks.

Its possible, just that its very hard cause Bitcoin is uncontrollable (no charge back).

Yes, if the system using such a system has enough people that have faith in their dealings not to scam them out of their deposits.

I have no problems with debt. I can borrow my neighbor's car and promise to give it to him back later. The problem I have with debt is when my neighbor instead of lending me his car will lend someone else's car to me (the original owner has no idea what happened to his car) pretending it's his and then charge me extra money for it. The real situation with our paper fiat currency is even much much worse than this.

No, they won't have any value without debt around it. Self-sufficient people beyond the state do not trade any metals with strangers. They are self-sufficient, because beyond the state and the society, there is no debt, and therefore no traded metal. There you'll find the self-sufficient community.


No, never ever in the history of mankind. Business, economy and money is based on the state and on the debt to the state (Mafia).
Beyond that, humans never ever needed Business and Money. They were self-sufficient, and in some rainforests, they are self-sufficient until today, because they live beyond the state and beyond debt. And therefore beyond business. They are not busy.

bitcoin requires no bank. having or using a bank for bitcoin would be stupid. put it in your wallet and leave it there, or spend it, or loan it. I don't recommend loaning it, unless you know and trust the person, get collateral.

without a bank there can be no fractional reserves.

the fractional reserve system is a scam against everyone but the bankers.

Yes, there will always be 21,000,000 BTC as money with no debt.  The reality is M1, M2 is not money, it is checkbook money.  The people of Cyprus found out it is not money.  However, our banks are FDIC insured, thus the government will most likely print money if it has to.

You can have money without debt.
You can have an economy without debt.  
You can have businesses without debt.

I argue the economy and businesses will be better off without banking debt.  If you buy shares in asicminer, you are buying equity. However in reality you are giving your money to someone else.

Hope I understood the post.

The base money is the only true money, M0.  M1 is checkbook money that acts like money.
M0 is the money at the federal reserve held as reserves, printed dollars at banks, and currency and coins in circulation.  M0 use to be really small.

No, that's History. No debt, no economy, no labor division, no collectivism. Instead of that, you'll find self-sufficiency of self-sufficient communities beyond any business, state and debt.


Yes, but no debt means no money, no economy, no business: self-sufficiency!

* You have 300 BTC and deposit it in a bitcoin bank
* they keep 30 on reserve and loan out 270 BTC
* this 270 ends up at another BTC bank
* they keep 27 and loan out the rest, ...

There will be fractional reserve banking.  However, the point is you don't have to participate.  Everyone has their own bank, their bitcoin account.  The idea the economy needs debt to function is just propaganda of the debtors, politicians, and banks.  Apple Computer and hundreds of other companies grew at 30% per year with no debt.   In fact the country would be much better off with no debt.  Imagine if CCMO was not able to deduct debt interest?  This is one of those fraudulent private equity debt transactions.  They load it up with debt and then since debt is repaid before corporate income tax it is beneficial to them as the total debt repayment is less than the inflation rate.  CCMO use to pay taxes to the government, as result of Bain adding debt they now receive tax money.  If their depreciation deductions stops they go broke.  However, if they had no debt they would be paying massive taxes and dividends to shareholders.

If you want to loan money to someone else do it.  I don't need a semi-retarded banker to loan my BTC to his buddies and be forced to bail him out when the bank ultimately crumbles.  I don't need auditors give phoney assessments to houses so people can pull money out of them.

In summary there is no fdic bailouts, no fed talp or tarp BS, no 0% discount indow loans to their banking buddies.  Thus, if you give you hard earned BTC to a bank, like pirate passthrough bonds, goodluck with your investment.  BTW, you will earn far more real value in your BTC account than any bank has paid in the last 50 years.  To put money in a bank today loses money a 5% annually.  If you want to make aloan, why not start with a bond or equity investment?

Warren Buffett has little money in bank accounts or treasury bonds why?  Because the are crap investments!

Of course it's possible. Question should be if that's something what market is asking for. It may occur in the future but I don't think we're heading that way.

And you repeating the same nonsense over and over again doesn't make it true either. What's the opportunity value of a $300,000 mortgage? The house increasing in value I would guess would be your answer. Okay, but do you think that can go on forever? Looking at recent history, nope it can't even though the banks thought they could inflate the bubble endlessly. So opportunity value is just an empty term you just made up and is still 'nothing'. It's something you expect to be valued more in the future (or produce more value), and when it doesn't well that's too bad the normal population suffers and bankers are bailed out by more debt. So the money is still in essence being created out of nothing and then lent out, it's an evil scheme especially if you consider the macroeconomic consequences and I'm sure you know that already. If not you should get your head out of the sand and look around.

It does not create money "out of nothing". Repeating the same false statement over and over again does not make it true.
The money that's finally created during the process of lending is created out of the opportunity value of the lent money.


No. In fact, as we speak, it's already happening and it has for quite a few years. It doesn't happen on a large scale, yet, though.

There will be a time when it starts to "get out of hand", though, and that will be when bitcoin is adopted by payment processors like e.g. paypal.
Imagine the scenario where paypal starts embracing bitcoin.
They won't require their users to transfer bitcoins into the paypal system before they can use it, but will rather make it possible for all their users at once to just use bitcoin like any other currency. I.e., you have a paypal account and want to buy something that's priced in bitcoins, paypal does the currency exchange for you and off you go. They will need a large stash of coins to do so but it will nowhere be near a 100% reserve for all their users' holdings.
Paypal is just an example here. The same would apply if banks let customers have accounts in bitcoins or with credit card companies, etc. pp., you get the idea.


It doesn't. In fact, for a reserve currency, the same rules apply as for any other currency, so I don't see where there could be any problem.
Bitcoin could make a good reserve currency because its monetary base is directly electronically transferrable, which is not the case for e.g. the Dollar or the Euro.

Thanks

I think this is the answer I was looking for. So in essence the bank would be issuing IOUs redeemable for bitcoin, not bitcoins themselves, is that correct? Analogous to how gold was used prior to 1971?

You can take the cash. But the more cash you hold, more value you loose by not earning any interest. So eventually cash finds its way back to to the banks, and cycle starts again.

It's possible but unlikely to happen on a significant scale. When a bank lends money the borrower doesnt usually take cash. Instead he gets bank credit. Since the ability of banks to create bank credit is almost unlimited (with central banks watching their back), voila you get FRB. But if I borrow Bitcoins from a bank I won't want bank credit. I will want the actual BTC. So there is no scope in that scenario for FRB.

Well, they don't need to pay it with USD, they just confiscate those big player and they got a pile of them for free.

A storage service is quite practical, but loaning out bitcoin is very unlikely, since there is a high probability that the borrower will never be able to payback the loan (due to fast rise in bitcoin value)

I doubt banks would take interest in bitcoins unless they control the majority.

I'm pretty sure it will happen, and as in the current situation you can store your money on a bank and trust them, or store it under you bed(in your own wallet) and trust yourself to keep it safe. Interest in Bitcoin might appear, as the banks can lend the bitcoins, or the banks charge some amout for the service of handling your bitcoins. Depends on supply and demand.

maybee all the feature a bank has to offer in order to attract deposits is "we have never been hacked"

clearly bitcoin banks would have to pay you interest, and/or provide features like exchange, off-chain transfer, etc... in order to get people to lend them money.

In order to have fractional reserve banking people must save money in bank accounts. To make people do that you must make their money worth less and less by printing more and more. So people are happy to be able to save money, with interest rate a little below inflation.  No inflation - no need to save bitcoins in a bank (unless the bank is paying you interest above inflation, loosing money, or convince people somehow to give them their money).

Fractional reserve banking started because gold and silver were not useful as a currency in an emerging economy (too expensive to divide and transfer). So gold ("money") was stored in banks and their receipts were used instead as a "currency". Banks were constantly lending out more receipts than they have gold and ultimately, took over the government to legalize the procedure. Then, the gold was almost outlawed as money (see 1933 confiscation decree by Roosevelt) and finally Nixon ditched any gold obligations from under USD.

Bitcoin is not only money (like gold), but also currency (like USD bills). When there will be efficient standalone wallets and vault apps and devices, people wouldn't need banks and wouldn't need money substitutes (bank promises). Therefore, discussing fractional or full "reserve" would be irrelevant. There simply won't be currency that needs to be "backed" by anything.

In certain cases of some clearing houses or networks, there will be some IOUs, but those would be automatically redeemed on regular basis without any emerging risk of bank run. Those IOUs will only be useful as means for micropayments or frequent payments. Since Bitcoin encourages savings, demand for credit would be much smaller and certainly not in realm of micropayments, so even small fraud in these clearing mechanisms won't be even viable.

Clearly, it is possible. Whether it will actually happen, though, I don't know.

I wouldn't be surprised to see most people start to use off chain transactions, which increases the chances of it happening by a ton. Already, places like Gox/Bitstamp could engage in such practices easily.

It is possible with off-chain transactions, it wont affect bitcoin value, but the "business" will crash when a "bank run" occurs...

Yes, this has been discussed before.  Try the search feature - I think you'll find what you're looking for.

Example from doing this: https://bitcointalksearch.org/topic/fractional-reserve-banking-in-bitcoins-nothing-prevents-it-22553

Hello,

My thought is this: since fractional reserve banking basically creates money out of nothing, wouldn't it be impossible to have such a system based on bitcoin? If so, how would this effect bitcoin's potential as a global reserve currency (if it indeed has any)?

(I've been a lurker here since April, and I've found these forums invaluable for understanding this great new mystery that is bitcoin. Some very smart people around here)