Bitcoin Forum

...because of fractional reserve.

So any assessments regarding price of 1 BTC seem to be incorrect. U can't just divide "world economics value" by 21 million.

Pirate's ponzi scheme is a good example of "perpetuum mobile" that generates bitcoins out of thin air. I mean that 500k debt generated 5k every day, and ppl were selling these coins for 50% of their "value".

PS: Not a divine inspiration, just an interesting idea to talk about.

Yes this is very true; however most of what Bitcoin replaces in the fiat world is not cash (M0) but funds in bank accounts, credit on credit cards, funds on deposit with Paypal or a similar service, money market funds etc.  M1, M2 or higher.

people who deposit their bitcoins in a fractional reserve institution will lose their bitcoins at some point. it is inevitable as bank runs on fractional reserve entities are not a question of if but are a question of when.

Yes it can work but it needs that banking attitudes of the prudent banks of the 19th century when the gold standard was used rather than what we seen in banking today, where banks with reckless banking practices are bailed out by the central banks printing more fiat money.

It's already here. I suggest to set a date for "Anti Fractional Reserve Day". During this day everyone should withdraw his/her coins from exchanges, webwallets and similar services to a personal wallet. And deposit the coins back in 24 hours. This "trick" will definitely help us to keep Bitcoin economy "healthy".

Right, but that really doesn't matter. People are so risk averse they miss the big picture. Yes, you will suffer the occasional total loss, but it can still be worth doing. Especially when the alternative is a constant slight drag and the probability of total loss is low.

A few months ago, I was explaining community credit to a man who owns a grocery store. He brought up the possibility that someone would default on their debts, even someone who had built up credibility through hundreds of legitimate transactions. My conversation with him basically went like this:

Me: Suppose that one out of fifty people did that to you. It would be like one out of fifty people walked out of your grocery store with all their normal groceries but didn't pay a dime.

Him: Exactly. There's no way I could stay in business if that was happening. It would be a disaster.

Me: A lot of your customers pay with credit cards, right?

Him: Yeah. Lots.

Me: How much do you pay on those credit cards? 2%, 2.5%?

Him: Yeah, about that.

Me: 2% is 1 in 50.

Him: *lightbulb goes on*

That's a good idea. First exchange this should be done to is MtGox. Who knows if they are operating on fractional reserve or not. As far as I know they don't have any publicly available audit data.

I love this idea. We should also include fiat deposits in bitcoin exchanges.
Let's do it on 30th September!

Although the idea could sound good we need to think about possible outcomes. I don't wish "Anti Fractional Reserve Day" to become "Bitcoin Economy Collapse Day".

With every collapse, Bitcoin grows stronger.
Not to mention that every collapse is a wonderful investment opportunity.

No.   >:(

http://www.strings.ph.qmul.ac.uk/%7Ebigdraw/feynman/lots_diagrams-main.jpg

“An Indian born economist once explained his personal theory of reincarnation to his graduate economics class,” Paul Krugman writes in the opening paragraph of his Preface to Peddling Prosperity. “‘If you are a good economist, a virtuous economist,’ he said, ‘you are reborn as a physicist.’” (http://www.asanet.org/footnotes/mayjun04/indexone.html)

https://bitcointalk.org/index.php?topic=108411.0

Fractional reserve banking (maturity mismatch of loans vs. deposits) does not necessarily cause credit expansion. Credit expansion requires that there is at least one fractional reserve instrument that is accepted as a substitute medium of exchange. With Bitcoin there are significant obstacles to this, because unlike with fiat/gold, financial instruments denominated in Bitcoin do not decrease transaction costs. I explain this in the wiki article: https://en.bitcoin.it/wiki/Fractional_Reserve_Banking_and_Bitcoin#Austrian_Viewpoint

I don't agree with this analysis. Any debt instrument has some value with the lack of liquidity and risk taken into account. Rational people wouldn't have any reason to prefer that same number of Bitcoins over the debt instrument. In fact, some people will prefer higher risk and some will prefer lower risk, so some people will rationally prefer the debt instrument over its market value in bitcoins.

With cash, there aren't many options to accumulate wealth by securing cash at a residence for example.

At some point cash can no longer be kept secure without additional costs and risk exposure, and the currency may be getting devalued to boot.

The options then include investing it as capital into a business, lending it to another party who will invest it in a business or other party that pays interest, or even converting the cash to another asset (e.g., precious metals) and storing wealth there.

With Bitcoin though, your currency isn't at risk of being devalued and it can be kept secure at minimal cost (when done properly).  So while many people have the mindset that they need to put their bitcoins to work earning interest, an even larger number of others will be content earning no interest on their stash of coins, just sitting on them until there is a good use for them.

Thus bitcoin currency overall can have a lower velocity (how many times in a period the currency changes hands) than other currencies.

Offsetting that tendency though is how when bitcoins are used for consumption, commerce, investment, lending, etc., Bitcoin's properties (nearly instant for payment notification and settlement, no chargebacks, useful globally, etc.) all allow the currency's velocity to skyrocket versus any other currencies that might involve the banking system or are restrained due to the laws of physics (delivering cash, in-person, to a supplier).



That's why the category of deposits called term deposits (also referred to as time deposits in the U.S., such as certificate of deposit / CD) and bonds will likely need to be more a widely used tool in the Bitcoin ecosystem so that lenders are less vulnerable to bank runs versus if they had only sight deposits (on-demand withdrawals).  

It would be trivially easy for an exchange or webwallet to be able to prove the amount of BTC they hold but unfortunately doing so reveals the deposits and withdrawal payments, which in turn violates customer privacy.  The webwallet problem essentially can be solved with a hybrid EWallet like Blockchain.info/wallet though that requires the account owner to configure the account properly.  For many, their chance of losing their funds by not properly configuring their hybrid wallet correctly (giving it an alias, getting backups to dropbox or e-mail, etc.) might exceed the risk of a trusted hosted (shared) EWallet absconding with the funds or getting hacked.

As far as exchanges, what SMPake is doing might help lessen the need to keep bitcoins at an exchange.   Many traders today store coins at an exchange as that is the only way to have a sell order remain active.  Exchanges needs this so that they can do instant settlement on each trade.    But if there is the ability to transfer funds in one block due to an intermediary like SMPake, then a trader needs to store fewer coins at any exchange but still is able to put up sell orders in a timely fashion.

That harms perceived liquidity though so maybe exchanges will be pressured to consider another approach.

Using M of N multisig, e.g., 1 of 2, the exchange can spend my funds even though they don't store them.  The problem is there isn't instant settlement with each trade -- the exchange is exposing themselves to the risk that the seller will issue a double spend (e.g., Finney attack to invalidate the trade).  But the exchange can counter this by simply restricting access to the fiat funds when that happens until the blockchain transaction for the trade has fully confirmed.

There are so many solutions available.  The problem is with so little competition, exchanges can follow the same current obviously flawed model that they currently use and make a little profit while passing on the cost of security to its customer base (in the form of direct losses resulting from theft).   Until the customers demand more, nothing will change.

Bitcoin is much less compatible with fractional reserve lending than any other type of currency. This is because there is much less incentive to deposit your money outside the blockchain, than there is with other currencies such as the gold standard or paper money. This doesn't mean that there won't be FRB in use, certainly services such as Mt. Gox or Coinbase could evolve to entities that will do this in a limited capacity. I don't think that there is any problem with it though, if the risks are managed in a smart way.

High interest investment funds could do this in a more risky way of course but that would be a high risk, high interest proposition. The average Bitcoin user would never touch something like that which means the effect of such operations are very limited for the overall Bitcoin economy.

Most importantly the base money (bitcoins) is totally inelastic and the possibilities for fractional reserve lending are limited due to the much higher hard money demand than with other currencies. I would say that this particular topic is something that Bitcoin actually has a major advantage over anything else out there.

It is important to realise the difference between value and money. Merely wanting to hold an instrument does not mean it is a part of a money supply. It needs to either directly be accepted as a substitute (roughly equivalent to M1), or be convertible into one at zero maturity (roughly corresponding to M2). Sometimes, longer maturity (roughly corresponding to M3/M4) is also considered part of the supply, but economists usually stop at M2 when performing macroeconomic analysis and forecasting. There is a reason why particular instruments are in different categories, and why these components are slightly different in each country. Not all instruments are either accepted as substitutes, or are convertible into M1.

The conversion of M2 requires that there are M1 instruments that can be increased as desired. In the absence of such an instrument, the only way to convert M2 (or higher) into money is by decreasing the reserves. Obviously, this can only go as long as there are reserves. So, in such a case, the reserves (i.e. monetary base) place the limit on the money supply.

You are right that other instruments can be relatively highly liquid, and affect the decisions of market participants. But only M1 is the most liquid (and M2 can influence M1). Commercial debt is sometimes put into M4, and instruments that are not redeemable at par are ignored entirely.

Exactly.  I accept that fractional reserve systems will eventually become, for some time, a part of the Bitcoin economy, and I don't intend to fight this through the protocol.  All I care about is that, if I don't want to take the risk, Bitcoin allows me a clear way to isolate myself from it, by only accepting "in the chain" bitcoins, so I dont' suffer from the inevitable bank runs that will hit the people who try FRB (and do it without Central Bank Sugar Daddy to backstop them).

I don't have an analogous option with existing fiat currencies.  Since central banks can print money to make up for any shortfalls and runs on banks, it doesn't do me any good to "only accept physical cash", since they can just inflate it right along with the pyramiding of loans.  No one can do that, however, with "in the chain" bitcoins.

I agree, but the thing is that these things are ignored only because we live in an economy where they *can* be ignored. If we lived in an economy where M1 was bound by fixed limits, we would likely also follow different rules for what can and can't be ignored.

I agree that the reason why they are ignored is primarily empirical. In our current world, there is a relatively strong contrast between money and non-money. I also think that a stark contrast would continue to exist in a Bitcoin world, only that the line would be drawn more closer to the specie and further away from financial instruments.

I think this is part of why I always thought having lots of alternate blockchain currencies should increase the value of bitcoins.

Basically the actual original genuine bitcoins would be the heavy duty most-valuable specie, with the greatest tendency to be hoarded, and the various alternate-chain coins would be used in preference wherever possible but with the number of bitcoins they can buy being used by most people as their method of guessing how much the altcoins are "worth" they would in effect be backed by bitcoins, thus the more value the proliferating altcoins manage to represent or channel or aquire the more value the fundamentally limited number of bitcoins that are in effect basically "backing" them all should aquire.

I guess this is also a large part of why I continue to think bitcoins are massively undervalued right now... There is more money tied up in various alternates than all the bitcoins in existence could buy unless bitcoins go up in value a lot.

Maybe other people are seeing it the other way around though? Like, maybe some of you are thinking the grand total value of all altcoins of all altchains all adds up to less than the value of all the bitcoins that so far exist?

Driving many of the alternate chains underground by attacking them might help you maintain such a view, however when I look at the valuation tables at http://galaxies.mygamesonline.org/digitalisassets.html I have to wonder...

-MarkM-

I don't see any need for fractional reserve banking at all.  It just doesn't work well and is an obsolete concept.  I say this in the context of both fiat currencies and Bitcoin.  Bitcoin just makes it more readily apparent that fractional reserve banking is on its way to obsolescence.  

With fractional reserve banking, when you deposit money (and let's define that as either physical gold, physical USD, digital USD in the form of a balance in a FED account, or genuine Bitcoins), you are trading in a ledger entry (whose value is not guaranteed and is determined by a market) for a debt instrument (and yes, physical gold, when used as money, represents a ledger entry).  The bank owes you what you deposited on demand.  If the bank is not paying any interest, and we're not talking about something inconvenient to store (like gold or physical dollars), there is very little reason for you to make that deposit.  If the average person had direct access to a FED account, that would be the safest form of electronic USD to hold and I'd say many people would much prefer to keep any USD savings in that form over say an account at Citibank.  Bitcoin is kind of like giving everyone direct access to an account at the FED.

So, what about interest payments?  That's a good reason to put money into a fractional reserve bank right?  I'd say not really.  The reason is that without something like the FDIC that spreads default risk to basically everyone holding any dollars, you bear the risk of default directly.  So, is that risk of default worth the 1 or 2% you might earn in interest?

I think the better alternative is to view the lending business (that supports the interest payouts on deposits) like we view any other businesses…one that has revenues and expenses, a balance sheet, income statements, quarterly reports….and stock.  Instead of putting your money into an account that creates this fantasy that it's actually there, buy stock in a lending business.  And there could be all sorts of options when it comes to the nature of the lending that the business engages in (from very conservative, asset backed lending to more high risk unsecured debt, etc).  ETFs would allow you to spread risk as much as desired.  The value of your shares will rise and fall with the performance of the business and market conditions, but you wouldn't be at risk of run on the bank scenarios (all you can do is sell your shares, you can't demand to be made 100% whole on your principal).  Holding bitcoins (once the market for bitcoins is saturated) are savings invested in the overall economy (where you gain from the overall increase in productivity), whereas holding shares of some company or loan portfolio are more directed investments in some subset of the economy.

There really is no point in creating the fantasy that fractional reserve banking creates and the chaos and cost associated with insolvency makes it less efficient than a share based model for lending.  So, my view is that fractional reserve banking is about to become a relic of the past…and deservedly so.

Heh that is basically what General Financial Corp (https://bitcointalk.org/index.php?topic=61557.0) has been doing. They borrowed a huge lump sum at half the interest rate they charge to debtors then obtained debtors by refinancing them at half the interest rate they had hitherto been paying. A win for everyone except the creditors who lost their debtors to GFC.

It was a major moneymaker for the folk who bought GFC at its IPO price of 20 DeVCoins per share too because basically they are making money off of other people's money far far more than they are making anything directly on that tiny token amount they paid at the IPO to form/launch the Corp.

In essence what they really invested in was the diplomacy skills and diplomatic clout they obtained by getting a bunch of heavy hitters to all join forces to form such a Corp.

-MarkM-

Fractional reserve banking allows maturity transformation, i.e. makes it easier to invest and easier for a market interest rate to emerge. With a bit of exaggeration I would say that it makes investment more liquid. If the fractional reserve instruments decrease transaction costs, you can expect that on a free market, FRB results in credit expansion (i.e. it affects the money supply), because the demand for saving and for lowering transaction costs manifest themselves in one product.

With sufficiently low transaction cost of specie, these two functions (medium of exchange vs. credit) remain separated. Bitcoin demonstrates that this is practically possible, as until now this has only been hypothesised or formulated indirectly.

If you go fractional with dollars and aren't stealing or sucking really bad at investing you'll be able to get all or most of the dollars back, possibly after some delay.

But since almost nothing is as awesome as bitcoins you (or people who deposit with you) are taking a huge that what you invest your bitcoins in won't be as awesome as bitcoin and even if you are fantastically successful in real terms you won't be able to cover your liabilities.

If you think bitcoin is awesome don't give them away unless you know what the person is doing with them and you think it is even awesomer than bitcoin.

And regarding the title, NO. If you think a promise of a coin = a coin you are going to get burned. The promises aren't bitcoins and aren't worth nearly as much.

I think that a tightly limited M1 would push the line further away. So we disagree over a hard to predict empirical fact about how the world will adjust to Bitcoin. I can't be sure your view is wrong, and I don't think you can be sure my view is wrong either. Which I think means that there could be much more than 21 million Bitcoins, but it's hard to say.

There is no doubt that lending is important, I'm not arguing against it.  What I'm saying is that fractional reserve banking is a less efficient model for making capital available than a typical share based model.  Regarding a "market interest rate", I'm not sure what you mean by that since all debt or investment carries some risk.  So, talking about about a market interest rate in the absence of the risk associated with that interest rate doesn't make sense.  If you're talking about the "risk free rate of return" often discussed in the context of government bonds, I'd argue that this too is an antiquated concept when examined next to Bitcoin.  When Bitcoin fully saturates the market (everyone is holding has much as they want to hold and using as much as they want to use in transactions) and is past its growth phase, the value of a bitcoin will rise and fall as people's preference for savings vs consumption (or riskier investment) changes.  The higher the preference for consumption or riskier investment, the lower the value of a bitcoin…the higher the desire for savings, the higher the value of a bitcoin.  This essentially serves the same function as treasury markets (where the interest rate paid is measured against inflation to determine a real rate of return, or some objective measure of value).

One other thing…people have debated with me in the past that the fantasy created by the fractional reserve model induces (aka dupes) more people into lending and that without it, there wouldn't be as much capital available.  While it might be true that more people would be lenders under a fractional reserve scheme, consider what that means for the rate of return for those that do lend.  Due to constricted supply, the yield available to lenders should be much higher…given high yields, I don't think it would be long before most people figured out that lending was a much better way to park their savings than bitcoin itself (again, we're talking about a time when bitcoin is beyond its growth phase, where the investment in bitcoin itself may be the best place to park savings).

Exciting times for certain.

Wow, talk about crackpot economy. As somebody had said a while back: Bitcoin is backed by gold, comedy gold. Don't you ever put anyone on ignore because you may miss the best comedy moments.

I'm not sure exactly what you're referring to, but I didn't mean to imply that bitcoin would take over the entire market for monetary instruments.  I meant when bitcoin is simply being used for exchange and savings rather than as a speculative/growth investment as it largely is today.

OK, I apologise. The humor in your posts requires a specific previous background to understand. It probably shouldn't be called humor at all on this forum.

The utopian world that you described in this thread resembles the syndicalist world-vision rooted in marxism/leninism. I'm talking here purely about economics, not about the other political/social aspects.

Whatever bad can be told about marxism/leninism at least most of the people agree that their analysis/critique of capitalism is internally consistent and has predictive power. In comparison with its m/l-roots the syndycalist economics is considerably weakened; primarily by disregarding internal inconsistences and replacing them with wishful thinking.

In particular the bolded part "everyone holding as much as they want to hold" is just one of the more hackneyed and ridiculed statements from a certain syndycalist manifesto.

My political-economics textbooks are in storage on a different continent, so I will not be able to give you a good citations and other scholarly backup for my posts here.

You infer a lot...I was not describing a utopian world.  I was suggesting that fractional reserve banking may not be the most efficient means of making capital available to borrowers.  And, as a result, I think it will become less prevalent in the future (irrespective of bitcoin's success or lack thereof).

It isn't much of an inference but more of a pattern matching. The writing style, the rhetoric, the hypothetical examples, etc.

It is probably unconscious to most of the American (US-ian) writers here: but the class struggle rhethoric is just hard to not notice. Of course the "workers" are replaced with "Internet knowledge elite", "dictatorship of the proletariat" with the "dictatorship of the blockchain", so on and so on...

This is partially what makes reading of this forum such a great, intellectually stimulating entertainment.

FRB allows for a wider risk spread. Even if it had no aggregate effect on the amount of lending, it would make it more granular.

Market rate of interest is, in the Austrian terminology, a reflection of the time preference, i.e. the propensity of people to postpone consumption. Similarly as you have a bid-ask spread for "normal" trades (e.g. if you look at the Mt. Gox order book), you also have a bid-ask spread on the credit market. What's in between is the market rate of interest.

While risk may affect where you invest, I don't think it affects whether you save. But apart from that we appear to agree.

Creating new money does not increase the availability of resources in the economy, it merely changes people's evaluations of that. So at best, FRB can trick people into unprofitable businesses. Here we appear to agree too.

But as I said earlier, even if there is no credit expansion (so we eliminate the effect on money supply), FRB still makes investment options more granular, i.e. it increases the efficiency of allocation of capital.

Definitely.