It will lead to the bust of many more exchanges and the theft of many BTC.
Our job is when it happens to teach people this is the correct way of how things operate and the gov should NOT be there to bail out bad players that have been raping you.
Topic: What is your idea about fractional reserve practice at bitcoin exchanges? (Read 3903 times)
September 22, 2014, 07:57:41 AM
September 22, 2014, 07:38:18 AM
I think this would essentially make it impossible to create new customer deposit addresses more then once per day (or would be limited as to how many they would be able to create).
No, it wouldn't. Why would you think it would?I think it would also create a false sense of security for keeping bitcoin at exchanges as multiple exchanges could potentially work together to be able to run away with their customer deposits.
Right now, exchange operators need to cooperate with nobody in order to run off with customer deposits. This would be an improvement. 
September 22, 2014, 12:01:39 AM
They should have third party software performing the Merkle construction once a day lets say. A second "third party program" could verify individuals account holdings (crypto only mind you) by checking hash values. This program would be encrypted and stored on exchange servers by a third party. Then individuals could be assigned personal private keys to decrypt and run the verification software as they please. The private keys could be stored locally on customer devices.
Encrypting and MACing the verification software would ensure the exchange themselves could not alter this software. As long as enough users verified their holdings periodically they might be able to prove the exchange was not holding less coins than that declared by the daily merkle tree.
This is not an audit of course, more like an inventory check. I am I missing something?
We can do much, much better than that.Encrypting and MACing the verification software would ensure the exchange themselves could not alter this software. As long as enough users verified their holdings periodically they might be able to prove the exchange was not holding less coins than that declared by the daily merkle tree.
This is not an audit of course, more like an inventory check. I am I missing something?
Exchanges can work together form m-of-n multisig pool in which to store customer deposits, then audit each other continually in real time, provided that they can provide cryptographically secure proof of liabilities.
This arrangement is called a voting pool.
Proof of solvency alone is pretty much pointless, since a fraudulent exchange can prove solvency right up until they decide to take the bitcoins and run.
The voting pool arrangement means that no exchange can unilaterally refuse to honor withdrawal requests - they have to convince a majority of the exchanges simultaneously.
So once they are deployed we should see a substantial reduction in the amount of exchange fraud, at least on the Bitcoin side (there's no such thing as multisig for USD).
I think it would also create a false sense of security for keeping bitcoin at exchanges as multiple exchanges could potentially work together to be able to run away with their customer deposits.
September 20, 2014, 09:42:13 PM
They don't need customer funds to earn money, they just need to create their own virtual funds
A simple example: I'm an exchange and I create an account with 1 million bitcoins, then I dump those coins to drive the price down from $500 range to $50 range, then I buy back all of those coins and drive the price back to $500 range. This account still have 1 million bitcoins but also have 1 million x $100 = $100 million dollars (Suppose the average profit is $100 during the sell-off). This is a very profitable business, I don't see the reason why exchanges don't want to do it?
From exchange's perspective, the only risk is: When they sell the coins, there might be large buyers absorbed all their coins thus force them to buy back at a higher price. But exchanges see all the clients' data, as soon as they see the large amount of customer deposit is arriving, they could always abort the operation before those fiat money are credited to the customer's account. They could even delay the deposit process to make more room for themselves
This is known as "speculating with customer funds". It's a form of theft. The US SEC routinely has people prosecuted for this. A simple example: I'm an exchange and I create an account with 1 million bitcoins, then I dump those coins to drive the price down from $500 range to $50 range, then I buy back all of those coins and drive the price back to $500 range. This account still have 1 million bitcoins but also have 1 million x $100 = $100 million dollars (Suppose the average profit is $100 during the sell-off). This is a very profitable business, I don't see the reason why exchanges don't want to do it?
From exchange's perspective, the only risk is: When they sell the coins, there might be large buyers absorbed all their coins thus force them to buy back at a higher price. But exchanges see all the clients' data, as soon as they see the large amount of customer deposit is arriving, they could always abort the operation before those fiat money are credited to the customer's account. They could even delay the deposit process to make more room for themselves
September 20, 2014, 03:42:28 AM
They should have third party software performing the Merkle construction once a day lets say. A second "third party program" could verify individuals account holdings (crypto only mind you) by checking hash values. This program would be encrypted and stored on exchange servers by a third party. Then individuals could be assigned personal private keys to decrypt and run the verification software as they please. The private keys could be stored locally on customer devices.
Encrypting and MACing the verification software would ensure the exchange themselves could not alter this software. As long as enough users verified their holdings periodically they might be able to prove the exchange was not holding less coins than that declared by the daily merkle tree.
This is not an audit of course, more like an inventory check. I am I missing something?
We can do much, much better than that.Encrypting and MACing the verification software would ensure the exchange themselves could not alter this software. As long as enough users verified their holdings periodically they might be able to prove the exchange was not holding less coins than that declared by the daily merkle tree.
This is not an audit of course, more like an inventory check. I am I missing something?
Exchanges can work together form m-of-n multisig pool in which to store customer deposits, then audit each other continually in real time, provided that they can provide cryptographically secure proof of liabilities.
This arrangement is called a voting pool.
Proof of solvency alone is pretty much pointless, since a fraudulent exchange can prove solvency right up until they decide to take the bitcoins and run.
The voting pool arrangement means that no exchange can unilaterally refuse to honor withdrawal requests - they have to convince a majority of the exchanges simultaneously.
So once they are deployed we should see a substantial reduction in the amount of exchange fraud, at least on the Bitcoin side (there's no such thing as multisig for USD).
September 20, 2014, 12:03:31 AM
They don't need customer funds to earn money, they just need to create their own virtual funds
A simple example: I'm an exchange and I create an account with 1 million bitcoins, then I dump those coins to drive the price down from $500 range to $50 range, then I buy back all of those coins and drive the price back to $500 range. This account still have 1 million bitcoins but also have 1 million x $100 = $100 million dollars (Suppose the average profit is $100 during the sell-off). This is a very profitable business, I don't see the reason why exchanges don't want to do it?
From exchange's perspective, the only risk is: When they sell the coins, there might be large buyers absorbed all their coins thus force them to buy back at a higher price. But exchanges see all the clients' data, as soon as they see the large amount of customer deposit is arriving, they could always abort the operation before those fiat money are credited to the customer's account. They could even delay the deposit process to make more room for themselves
This is known as "speculating with customer funds". It's a form of theft. The US SEC routinely has people prosecuted for this. A simple example: I'm an exchange and I create an account with 1 million bitcoins, then I dump those coins to drive the price down from $500 range to $50 range, then I buy back all of those coins and drive the price back to $500 range. This account still have 1 million bitcoins but also have 1 million x $100 = $100 million dollars (Suppose the average profit is $100 during the sell-off). This is a very profitable business, I don't see the reason why exchanges don't want to do it?
From exchange's perspective, the only risk is: When they sell the coins, there might be large buyers absorbed all their coins thus force them to buy back at a higher price. But exchanges see all the clients' data, as soon as they see the large amount of customer deposit is arriving, they could always abort the operation before those fiat money are credited to the customer's account. They could even delay the deposit process to make more room for themselves
September 19, 2014, 07:13:17 PM
Banks use fractional reserves because they invest and borrow money, so they gain money with the customer's money.
But how an exchange can earn money with customer's funds? They don't borrow money, also they don't have the same level of protection from the State as banks.
Can't see it not ending as Gox.
But how an exchange can earn money with customer's funds? They don't borrow money, also they don't have the same level of protection from the State as banks.
Can't see it not ending as Gox.
They don't need customer funds to earn money, they just need to create their own virtual funds
A simple example: I'm an exchange and I create an account with 1 million bitcoins, then I dump those coins to drive the price down from $500 range to $50 range, then I buy back all of those coins and drive the price back to $500 range. This account still have 1 million bitcoins but also have 1 million x $100 = $100 million dollars (Suppose the average profit is $100 during the sell-off). This is a very profitable business, I don't see the reason why exchanges don't want to do it?
From exchange's perspective, the only risk is: When they sell the coins, there might be large buyers absorbed all their coins thus force them to buy back at a higher price. But exchanges see all the clients' data, as soon as they see the large amount of customer deposit is arriving, they could always abort the operation before those fiat money are credited to the customer's account. They could even delay the deposit process to make more room for themselves
September 07, 2014, 04:04:55 PM
Banks use fractional reserves because they invest and borrow money, so they gain money with the customer's money.
But how an exchange can earn money with customer's funds? They don't borrow money, also they don't have the same level of protection from the State as banks.
Can't see it not ending as Gox.
But how an exchange can earn money with customer's funds? They don't borrow money, also they don't have the same level of protection from the State as banks.
Can't see it not ending as Gox.
September 07, 2014, 02:47:21 PM
Fractional reserve exchanges are a terrible idea. I think all of them should be required to have audits showing they have 100% of everybody's coins. Leveraged trading is okay if everything is transparent like Bitfinex, but not just making BTC out of thin air.
The only way that bitfinex can lend bitcoin is by borrowing bitcoin from it's other users (it would be too expensive to lend out their own bitcoin). Bitfinex is essentially working on a two tier system. One - 100% reserves for people who simply have their bitcoin on deposit there. Two - fractional reserve for people who have invested in swaps, these people receive some amount of interest in return for being on the fractional side.
September 02, 2014, 02:44:15 AM
Fractional reserve exchanges are a terrible idea. I think all of them should be required to have audits showing they have 100% of everybody's coins. Leveraged trading is okay if everything is transparent like Bitfinex, but not just making BTC out of thin air.
September 02, 2014, 02:40:30 AM
Those companies need to change their names. The idea of exchange cannot get along with the idea of fractional reserve, and this is just another reason not to leave any money at an exchange. Exchanges are made to trade, nothing else. I guess some people haven't learned anything from the MtGox fiasco.
Right. A big problem with Bitcoin exchanges is that they act as broker, custodian of assets, transfer agent, and exchange. In the real world, those functions are separated.The NYSE does not itself handle money or stocks. It's just an order-matching service.
August 24, 2014, 02:53:56 PM
As long as they are very clear about what they are doing I don't have a problem with fractional reserve in principle, but if exchange owners are doing this to trade on their own exchange to the detriment of other users then surely people would just move to a different exchange?
If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.
What most exchanges that are likely operating on a fractional reserve are likely doing are spending their customer money. What a "real" fractional reserve exchange should do is use a portion of customer deposits to lend money to borrowers with the hope that, after interest payments and customer defaults, they will have a net profit on their loans. If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.
Exchanges could lend these coins to themselves to short the market and trigger speculator's stop-loss. Since they have all the customer's coins on exchange, based on FRB principle they could borrow 90% of the coins, they could greatly crash the price to wipe out everyone, because no single big whale have the amount of capital to deal with all the coins on that exchange (Whale's money is only part of that pool)
For example, an exchange have 50k coins, and the amount of fiat money on exchange is 25 million, which maintains an exchange rate of $500. Then exchange borrow 45K coins to themselves and short the market, so all the fiat money on that exchange will be quickly drained, and the exchange rate could cut by half or more
Then the bargain hunters will rush in to deposit and buy coins to withdraw, money arrives after several days, exchanges will soon find out that they are facing a much larger withdraw than 5K coins (the rate under normal market condition), that will dramatically reduce their reserve and they have to buy back coins to reduce the withdraw pressure, then the price will recover quickly
Bitcoin world is wild west, no regulation on exchanges for what they can do
August 22, 2014, 09:48:18 AM
Fractional reserve is ok if they are willing to cough up any loss due to taking risk on directional bet or even lending.
Great observation, as long as the banks/exchanges take their own loss, they can do whatever they want. But in reality, since customer's money is kidnapped by them, you have little option if they incur a huge loss and have nothing for you to withdraw
August 22, 2014, 09:37:55 AM
As long as they are very clear about what they are doing I don't have a problem with fractional reserve in principle, but if exchange owners are doing this to trade on their own exchange to the detriment of other users then surely people would just move to a different exchange?
If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.
What most exchanges that are likely operating on a fractional reserve are likely doing are spending their customer money. What a "real" fractional reserve exchange should do is use a portion of customer deposits to lend money to borrowers with the hope that, after interest payments and customer defaults, they will have a net profit on their loans. If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.
Exchanges could lend these coins to themselves to short the market and trigger speculator's stop-loss. Since they have all the customer's coins on exchange, based on FRB principle they could borrow 90% of the coins, they could greatly crash the price to wipe out everyone, because no single big whale have the amount of capital to deal with all the coins on that exchange (Whale's money is only part of that pool)
For example, an exchange have 50k coins, and the amount of fiat money on exchange is 25 million, which maintains an exchange rate of $500. Then exchange borrow 45K coins to themselves and short the market, so all the fiat money on that exchange will be quickly drained, and the exchange rate could cut by half or more
Then the bargain hunters will rush in to deposit and buy coins to withdraw, money arrives after several days, exchanges will soon find out that they are facing a much larger withdraw than 5K coins (the rate under normal market condition), that will dramatically reduce their reserve and they have to buy back coins to reduce the withdraw pressure, then the price will recover quickly
Bitcoin world is wild west, no regulation on exchanges for what they can do
August 21, 2014, 11:18:40 PM
As long as they are very clear about what they are doing I don't have a problem with fractional reserve in principle, but if exchange owners are doing this to trade on their own exchange to the detriment of other users then surely people would just move to a different exchange?
If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.
What most exchanges that are likely operating on a fractional reserve are likely doing are spending their customer money. What a "real" fractional reserve exchange should do is use a portion of customer deposits to lend money to borrowers with the hope that, after interest payments and customer defaults, they will have a net profit on their loans. If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.
August 21, 2014, 10:56:43 AM
Those companies need to change their names. The idea of exchange cannot get along with the idea of fractional reserve, and this is just another reason not to leave any money at an exchange. Exchanges are made to trade, nothing else. I guess some people haven't learned anything from the MtGox fiasco.
August 21, 2014, 10:35:44 AM
As long as they are very clear about what they are doing I don't have a problem with fractional reserve in principle, but if exchange owners are doing this to trade on their own exchange to the detriment of other users then surely people would just move to a different exchange?
If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.
If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.
August 21, 2014, 10:25:09 AM
Of course not, but the question is what you can do to prevent them from creating too much volatility in market?
Educate people to avoid exchanges without proven reserves.
As long as people are aware that these exchanges are doing fractional reserve, the selling of fractional reserve bitcoins should not affect the bitcoin price. Real bitcoins will trade at a higher price than bitcoin IOUs.
August 21, 2014, 10:10:25 AM
leverage and margin trading is destroying the Bitcoin price ...
What do you mean? By historical standards the price has been remarkably stable lately.
August 21, 2014, 09:31:33 AM
Fractional reserve is ok if they are willing to cough up any loss due to taking risk on directional bet or even lending.
I 100% disagree. It is criminal our entire monteary system is criminal.
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