Bitcoin Forum

Hey guys, I'm almost sold on BTC, but here's something that I can't get over it: the fact that BTC does not allow some sort of controlled credit creation.

I believe you heard this argument before and if you can explain it to me or point me in the right direction I would appreciate it.

The issue that I see with Bitcoin is that it doesn't allow credit creation. (and no, loans are not the same thing, they are just a redirect of the capital from other purposes)

Before telling me how credit is bad and this has doomed our current system, I would like to tell you that I do share that idea on credit is bad for ... consumption! You shouldn't consume more that you produce and if you want to consume more, well, go produce more money (aka get another job or a raise). Or start saving for that new car model and buy it when you have enough money. Just like the balanced budget that our governments are trying to achieve.

However, credit as capital investment into production is something good. If there is no credit, basically a company that produces goods and services which wants to expand, it would have to start saving those money and in one, two whatever how many years would have enough money to buy that new warehouse, land or equipment. Well, that sucks; I don't think we'll progress too fast with this approach.

There is also a blur line between credit for consumption and credit for production especially when the consumer and the company both default on the loan. Those money would be "lost" no matter their initial purpose.

Bitcoin tries to solve this problem with a simple answer: no credit whatsoever. This becomes obvious especially after the 21 mil Bitcoins are mined.

So how can Bitcoin have a future if it is a deflationary currency with a set in stone number of coins? After 21 mil BTCs are mined even loans are not the answer because there is no money created to cover the interest. If everybody start making loans with interest, there will soon be not enough BTCs in circulation to cover the interest, not to mention the principal. Maybe loans at 0% since the currency appreciates itself and the appreciation is like an interest? Well, why take the risk to loan the money at 0% and not just keep it in your wallet with no risk of losing them. They'll appreciate there with no problem.

That's the big fail I see in Bitcoin. Please convince me that I'm wrong.

Just because there are only 21 million actual bitcoins, doesn't mean the bitcoin economy is restricted to that amount.

I think Joel Katz is good at explaining this, although I'm not sure if he'll bother since he has done so many times on this forum already.

For example, it is entirely possible to accrue a legitimate debt greater than 21 million BTC, and furthermore it is possible to be able to repay such a debt.

There is nothing preventing fractional reserve banking and credit, based on Bitcoin, just as in the past it was done, based on gold.

Wouldn't having a fixed amount pretty much prevent that? It's not like I can give you some BTCs if I don't actually have them in my wallet.dat file.

Or you're talking about the creation of some paper IOUs that have BTC value? Err, isn't that creating a new currency then? Let's call it USD :) It's like going back to the flawed system that we have now.

Growth isn't necessarily always a good thing... look at everyone complaining about global warming, etc. If the company really is a good investment they will find investors.

Indeed, fractional-reserve bankster paper did seem to make sense 100+ years ago on the basis that gold was (is) heavy and awkward to move around. Today, however, paper is not easier to shift than BTC so that logic largely no longer applies. Nonetheless, theoretically there is no reason why people couldn't agree to trade BTC promissory notes if they really wanted to.

Is it too much to ask for people who think they've discovered a major, obvious flaw in Bitcoin to maybe search the forum and see if there aren't already a billion threads discussing this very thing?

Maybe, just maybe, you aren't the only person bright enough to come up with the same question.

Yeah, I know. Don't we all hate when noobs just go out and create new topics on existing info?

I found a couple of threads (i.e. the deflationary one right here, in this section) but they were only "side talking" about the credit option needed or not. And this forum is huge, with a lots of topics that have for example deflationary as the searched keyword in them. I can't possible read them all. Sorry. I had to take a shot at creating a new one laser targeted on what I strongly feel is a drawback of Bitcoin.

If you already found/bookmarked topics that talk about the same thing, do share. Thanks.

Oh snap, we overlooked this major fail. Wrap it up guys.

Lol.

Now seriously, can we not turn almost every thread here on mockery?

If you want credit, YOU have to create something (a good promisse to pay back), not the issuer.

I think the fact that Bitcoins are currently actually made up of 100 million Satoshi's  each should be part of the basic introduction to this way of transacting. That means that there are potentially 2100 trillion currency units available. And you can always add more decimal places...

OP I am wondering why you think this is a stupid or uninteresting perspective since you seem to have skipped over it.

Maybe the invention of "credit" is a bad thing? ::)

True, however what I meant was that it's entirely possible to have a billion-bitcoin economy. Even 1 billion bitcoins worth of economic activity on a daily basis.

Not stupid but it opens another can of worms. So, let's assume growth is a bad thing. Can you separate Growth from Technological evolution? Don't think so. So are we saying that growing a business and making it more efficient is bad? Invention and new products is bad?

Ok, let's look at it from another perspective. Do you want your kids to live better? Also, should all countries on Earth have the 2 kids maximum policy? So that the population on Earth stays the same, so that we don't need extra goods or resources, so that companies just produce the same amount of goods and services, so that there shouldn't be a need for growing and new jobs. With no growth in production and yet a growing number of people that require resources and jobs, we'll end up with social unrest, right?

People want many various things to varying degrees, it is all very complicated. A good way to get those things is from other people. A good way to do that is with an intermediary 'counter' that is durable, easy to transfer, easy to identify. Bitcoin totally fits, unless it turns out that one of the main things most people want is to see a bigger number and not more or better stuff and experiences.

Does growth cause "technological evolution" or does technological evolution cause growth? Is growing a business always the best way to make it more efficient? Should government policies act to prevent possibly undesirable population growth or should they encourage it? I dunno that whole post is filled with correlation not equal to causation and other fallacies. I'm not sure you have thought these positions through.

With technological advancements you can do the same with less or you can do better (higher quality) with the same. So it doesn't necessarily mean growth.

Growth was only needed to pay the interest on the money we borrowed. With Bitcoin the economy will start converging to balance instead of growth and that's exactly what we need in the current situation.

I'm not sure, and I'm probably going to end up demonstrating my own lack of understanding but...

I've always assumed that when bitcoin reaches mainstream use we will find there are "banks" where you can safely deposit your bitcoin into an insured account.  I figure the main driving force behind this is the average persons lack of ability and motivation to learn to protect their bitcoin from accidental loss and theft.  These accounts will likely find a way to collect a small fee based either on the storage of these coins or on the use of these stored coins.

Assuming this ends up happening, transactions between members of an individual bank will no longer require movement of any bitcoin on the blockchain at all.  The bank will simply credit one account in their own database and debit another.  The entire balance stored by the bank will be safely secured offline in addresses owned by the bank itself.  Furthermore, transactions between banks can wait a predetermined amount of time (perhaps daily?) before the banks settle up their accounts.  So if various members of bank-A send 1,000,000 BTC to members of of bank-B, and other members of bank-B send 1,000,001 BTC to members of bank-A, then at the end of the day bank-B sends 1 BTC via the blockchain and everything else is handled internally by the two banks.

Using this system, wouldn't it be possible for those banks to engage in fractional reserve?  Assuming that the members of the bank are willing to allow fractional reserve in exchange for lower account fees, couldn't the banks potentially loan some percentage of their holdings to business for growth?  Wouldn't this be "credit creation" and allow for the "existence" of more that 21 million BTC?

The whole question has zero relevance.

Unless there is a law for a country to ONLY use Bitcoin, Bitcoin will never 100% replace local currencies.

You look at Bitcoin as if it would have a monopoly and be the only currency.

Than your fear would had relevance. Now thats not the case.

People will allways want and need local currencies to keep trade in their area etc and governments will allways want that kind of power. So they will keep demanding taxes to be paid in their currency.

This means, that you will have both kinds of currencies.
So you can have it your way with creditcreation and still own Bitcoins.

What would be the point of Bitcoin if it was like every other currency?
Who would controll the creation of new currency? In a decentralized manner?
How would it be controlled?

There is a very high risc that those two questions would open up Bitcoin to someone to game the system.

Lets imagine you want to trade with someone over a couple of years.

In one currency you have no idea how many units of that currency will be created.

In another currency you know exactly how many units there will be.
This gives you a knowledge of exactly how much of that currency you own and will own in a couple of years.
No matter what.

If noone of you can control this, you will trade on 100% equal terms.

Listen to this:
http://www.youtube.com/watch?v=ltIidNNcVgo

He describes systems with two kinds of currencies one that holds it value and one that dont.

Let me try again.

Population growth needs to be matched by production growth just to keep the living standards at the same level. It's simple math: the more people need to be fed, the more farms need to be built or existing farms need to expand production. For farms to expand, they need credit.

A company builds cars and competes in the market with other 10 companies so it needs to continuously improve its cars to stay competitive. To improve the car, the company needs money to set aside for R&D, create new lines of production, upgrade existing lines, etc. To achieve this growth, it needs credit.

We all want Bitcoin to succeed, so ...


 ... so, if the definition of success is not general acceptance or International currency status like USD or EUR then ishtar is right; the whole question has zero relevance.

 

I don't see why Bitcoin and credit are mutually exclusive. Sure the people that are paranoid about banks and centralized control will keep all their coins in secure offline wallets, etc. But as is proved by the lending section, there are numerous people who are willing to deposit their coins with another person in exchange for a set return. Now take this number of people, who are willing to risk losing their coins by depositing them in very questionable places, and imagine the number of deposits if there was a brick and mortar place with fully available contact information and transparency as to how your funds are being managed. I would think this would get a lot more people comfortable with depositing than the current "banks" in the lending section of these forums. As Bitcoin gets more and more mainstream acceptance, there will be people who are not knowledgeable enough about computers and Bitcoin to secure their own funds, and they will be drawn to banks of this nature because that is the manor in which they are used to securing their money.

Any time there is an entity with more than one or two deposits, it's possible to engage in fractional reserve banking. If they have BTC10,000 worth of deposits, they can easily loan a business BTC2,000 because it is unlikely that all of their depositors will withdraw their total balances at once. So in essence they just created BTC2,000. Their depositors "own" 10,000, and the business that borrowed has 2,000. Hence, credit. It works the same way with any monetary system, why would Bitcoin be any different?

Oops, this is where you go wrong.  Growth does not require credit.  Growth requires saved past production (commonly known as "capital").  Credit just means that it isn't the grower's capital.  Manipulation of credit also does not magically make that capital spring into existence.

The debt system allows businesses access to more capital than they would have access to on their own, and it allows savers more access to growth than they could do on their own.  Equity investing is another way to do this, and it offers different risk/reward profiles.  Having both gives both sides more options.

People are already able to trade MtGox redeem codes rather than btc. Does that fit under the btc promissory note category?

Nope. Depositors own 8,000; the business has 2,000. You can not create credit with BTC because you can not spend money that you don't have. Each transaction will remove btc from your wallet and add it to someone else's wallet.


I did mentioned previously about the savings which can be used as source of credit. Each company would save first the amount they need to built the new thingy they need to grow. Well, not so fast. Perhaps it can work with small companies that need to buy and hire an extra service desk or a small building, but with large companies or small companies that have R&D costs ... this is painfully slow. Think about mining companies. They have huge upfront costs when opening a new mine. Even with credit available it's hard for them to get all the capital they need. And then it takes years to do exploration, drill holes and setup shafts. Add more years to save all that money upfront.

You don't seem to grasp how fractional reserve banking works.

When the depositor deposits btc to the bank, the bank now has the btc, the depositor owns imaginary btc, call it iBTC, which cannot be sent through the blockchain, but is still an asset. Now the bank lends the btc to a loanee, sending the btc along, and the depositor and the bank now both only have iBTC, the loanee has the actual btc.

I do. And I already replied to a similar question on the first page. So, are you also taking about the creation of some promissory notes or IOUs that are "backed" by deposited BTC?

Because with "real" BTC you can't make 12,000 out of 10,000.

Why does it matter if they are real bitcoins, or a system of credit built up on top of bitcoins?

The point that you are missing is that the capital was saved in advance either way.  Credit just changes who has access to it, and under what terms.  Equity investing does the same thing.  Neither one is required for growth.

And I disagree totally about the length of time it takes.  Accumulating the capital takes the exact same time either way.  Again, credit does not magically cause capital creation.  It can change the way that capital is allocated, but it doesn't create it.

That's pretty much the definition of fractional reserve banking, right?

"Real" bitcoin is nothing more than a promissory note recorded on a ledger that we call a "blockchain".  If fractional reserve banking develops within the bitcoin community, then the ledger simply moves from the blockchain to the bank's database, and the blockchain becomes a way for banks to settle up their inter-bank transactions at the end of the day.  So you are then talking about a fractional reserve bitcoin currency "backed" by the blockchain bitcoin currency.  If they are both just promissory notes, and are fully interchangeable on a one for one basis then which is the "Real" bitcoin?

It matters because we will end up with the system that we have now. And imho Bitcoin is good because is nothing like the system we have now. It just has this tiny little problem of credit.

What you're describing sounds eerie similar with the early stages of the gold based dollar. Blockchain = gold reserves in the bank. Promisory notes = USD. And we all know what happened next. Who needs that pesky blockchain anyway?

This is a tired topic for me, but I will once again offer a quick response to the OP.

1) Bitcoin does not provide for fractional reserve banking (what you really mean by 'credit' here), because it's designed to be a rigid monetary base, just like gold was prior to 1900.  This does not mean that fractional reserve banking is impossible.  If Google or Amazon decided to jump on the Bitcoin bandwagon, and offer deposit accounts in bitcoin, they could rationally loan out more than they actually had because there would be at least some people willing to accept the word of Amazon as being functionally as secure as if Amazon provided the actual bitcoin transfer.  However, this would also mean that the ratio would be more rationally limited.  Instead of a 9:1 lending ratio, as is the current limit for FedReserve member banks in the USA; Bitcoin banks would not be limited by law, but by the threat of competitors forcing a run.  This would likely result in a ratio closer to 2:1 for healthy banks, and unhealthy banks would go bankrupt when a competitor forced a run.  Such runs would also destroy the value of deposits.  This is how banks worked prior to 1913.

2) Credit is not what you understand it to be.  Capital is not credit, that is mathmatically impossible.  Capital must always exist, so if credit is not sufficiently backed (i.e. not capitalized) then it will eventually collapse upon itself.  Capital isn't money.  Capital is productive goods and the knowledge to use them in order to produce.  For example, a tractor is capital to a farmer, and a tractor can be valued in monetary units, but that amount of money is not the captial.  To just create money to be used as credit for capital goods does not create more capital goods, it simply inflates the nominal unit price of such goods.  The tractor must exist.  Expansion of credit for the purpose of "stimulating" capital production is a useless endeavor.  It's akin to taking buckets of water from one end of the pool and pouring into the other end.  All you do is alter the flow of the water, not alter the amount or distribution of water in the pool.

3) When and if investment banks are necessary for the growth or health of the bitcoin economy, the market will provide such.

The trick is to eliminate the possibility of runs. When you put your money in an interest paying account, it is agreed that it is not in the hands of the bank and it may take you time to have access to it. The fiction that you still have it needs to stop. If you want the bank to hold your funds, they would be required to actually have them on hand and provide them to you immediately on request (they would also likely charge you for the service).

Nothing "needs to be" here. There is no guaranted ticekt to eternal, infinite growth.

Indeed, anyone wanting just more apes jumping around at this crowded planet ist nuts, IMHO.
Like it or not, the free lunch is over. What's wrong exactly with having only two children?

Either we're doomed, or we learn to repay all the dept created by our parents and grandparents (economical, political and environmental) and make up for all that unjustified growth, and finally learn to keep an sustanable level of economy.

Incidentally, there is another escape from that catch: we could actually manage to expand to our neighbour planets.


Anything else beyond that are just pipe dreams.
Gowth is not a solution to any problems

That would be an undesirable 'trick' indeed.  The free market requires failures to actually fail in order to progress.  That is part of why we are stuck in an economic rut these days, because TPTB are making mistakes similar to 1933 when they should be doing the things their predicessors did int 1920. 


On-demand accounts are, for all practial purposes, entirely useless within the Bitcoin economy.  That's one of the functions that your bitcoin client provides for you at the cost of processor time.  No bank could compete with that, nor can any payment settlement system (think Western Union or SWIFT) compete with the Bitcoin network's cost effectiveness and speed in this catagory, either.  The only function that a traditional bank could offer the Bitcoin economy would be interest bearing accounts in return for investment lending. 

The greatest impediment to widespread Bitcoin adoption is the idea that credit cards are faster.  They are not, and any online vendor would be able to tell you it can take up to 40 days for such transfer to "settle".  Bitcoin transfers are usually settled within an hour.  Transfers among users of the same online wallet, so long as both users were trading using their online wallet account to trade, occur as fast as Paypal and for the same reasons.

I disagree (With the first statement, not the second). A lot of the problem is the fiction that the bank can lend out your money and yet still have it available. Simply making it clear that your money is either here or there but not both would effectively put an end to runs.


Mostly. I suspect I could come up with a couple of scenarios where it would be advantageous for others to be holding my money but I agree that such a system would be largely superfluous for most of the population in a bitcoin economy.


Agree. I think hardware wallets may have a big future in the Bitcoin world.

While I agree that honesty in banking would go a long way to resolving this issue, it would not put an end to bank runs on poorly managed banks, nor should it.


Yes, I'm still waiting form my bitcoincards.  I've got five kids, and I'd have at least one per kid in the first run.

I disagree with this.  My opinion is that an insured banking system will eventually be developed to provide security against theft and loss as well as ease of use for the technically disinclined.  Rather than providing an interest bearing account, it is entirely possible that these banks will charge either a storage fee or a transaction fee for providing this service.  Some of these banks may engage in lending (either through fractional reserve, or by providing as a service (for a fee) connections between borrowers and lenders.

Not being useful for the artificial creation of credit through inflation is perhaps the most appealing feature of Bitcoin, economically-wise.

If you think there's anything good in artificial credit created from inflation, please read: http://mises.org/daily/672

Even the ECB "got" that, by the way.

Did you guys see the Digital Coin video?
Video link: http://www.digitalcoin.info/Digital_Coin_Introduction.html

It looks like the proposed solution of the combined Perpetual coin (aka Bitcoin) and Credit coin might "solve" the problem of credit.

Your thoughts on the suggested system?

I invision a future that online wallet services will be bonded, insured and interconnected; and thus be able to provide for near-instant transfers to 98+% of the bitcoin users regardless of which wallet service that they use.  I don't regard this to be equal to wallet services becoming banks, even though this kind of interconnected distance transfer service is a large part of what we commonly think of what a bank does today.  That is not to say that wallet services cannot become true banks, or that a bank cannot offer a wallet service, but they are not equivilant.  I honestly don't have any idea if, or how much, a future user of wallet services would be willing to pay as a monthly service fee for this kind of service, which isn't much of an upgrade from what the client can already do.  The only way I can foresee such pay-to-play services becoming common among bitcoin users is if the transaction traffic were to increase to such a degree that a standard blockchain transaction were to become so expensive as to justify a parrallel/overlay network of major wallet service users that can save users' money by avoiding blockchain transactions altogether.  Such a parrallel/overlay netowrk is not simply likley, it's already occuring, as that is what Stratum does.  But again, Stratum is a free client that anyone can use, so I don't know how profitable such wallet services could ever realisticly become.

Just FYI, fractional reserve was invented for gold.  Goldsmiths created the practice by issuing more warehouse receipts (bearer certificates) for gold in their warehouses than they actually held in gold, and those receipts (certificates) were already circulating as money because they were much more convenient than actually fetching and hauling gold around.

In practice, this is pretty safe, since most people won't want their gold all at once.  Keeping healthy reserves will reduce the chances of being unable to meet a withdrawal request (a bank run) to whatever level is deemed appropriate by the bank.

The real innovation of the Federal Reserve system is that the Fed is able to create dollars out of thin air and can lend them to member banks instantly, making bank runs entirely impossible.  This really just passed the danger up the chain though, leading to the closing of the gold window when France (and friends) attempted to redeem lots of dollars for gold.

In the bitcoin world, fractional reserve is still totally possible.  It is just risky.  A bank that does it faces the very real chance of not being able to make a bitcoin transaction to back up a depositor request.  Banks can mitigate this risk to some extent with pooling and interbank lending agreements, but that exposes the pool to a much lower chance of a much worse event, and it will be impossible to eliminate the risk entirely.

This exactly, way better than I could put it.  What is capital? It is resources and efficient ways to use those resources (tech). If people get access to resources and/or develop ways to utilize their resources more efficiently then the result is growth, which leads to credit. Any other source of credit creation is just wealth transfer, which may lead to more efficient resource utilization or it may not.

I'm just curious, why exactly do you think loans can ever only be made if interest can be charged? Do you not think loans could have a different kind of a price?

I'm not sure why you have to magic up money to pay the interest either. Could there be no interest charging loans in a gold-only economy?

Yeah, it's kind of a rediculous statement, considering interest predates fractional-reserve lending and 'flexible' monetary systems by 4000 years.

Capital corresponding to ready-to-spend goods/services, and it normally depreciate slowly(Any kind of captial lose value over time, factory, machine, stocked goods etc...)

Capital in gold/silver's form do not depreciate, so they are generally regarded as a better medium for capital, then there is less risk that ready-to-spend goods/services will depreciate, since they will be produced when gold/silver is paid to producer. But there is a risk of inflation when lot's of gold and silver enter the market at the same time

Loan corresponding to future goods/services, it does not depreciate, so generally loan is a higher quality asset, cost of ownership is almost 0, if the default risk can be contained

+1

If credit implies interest, then, it's a flaw in itself.  If interest are charged, the fund for paying back those interest just dont exist.  Eg : There is only 100 $ all around the world, and it's mine.  Someone borrow me that 100$, and I charge 1% interest.  This borrower would never be able to give me the 100$ + interest, because there is only 100 $ in existence.. 
That's why bankruptcy are built-in in this "credit/interest/fract-banking" system..

That built-in need for bankruptcy (interest) is a major cause of the faillure of the actual monetary system world-wide.

Perso, I dont wish to create a feature in Bitcoin that renders bankruptcy inevitable.

was my 2 satoshi

Your belief that there is a problem is based on the assumption that 100% the BTC is hoarded and nobody spends it. Then there would be no ability to pay interest because there would be no way to acquire more BTC. That might happen in a hyper-deflation scenario, but it wouldn't happen normally.

These examples should prove that there is no problem.
On a small scale, I can loan you 2 BTC, and you use it to earn 4 BTC, and pay me back 3 BTC.
On a large scale, I could loan a company 2 million BTC, it manufactures products and makes 4 million BTC, and it pays me back 3 million BTC.
On a larger scale, I could loan a country 20 million BTC (over time), it uses it to fund Social Security, and it pays me back 30 million BTC (over time). Of course, in this case both parties would have to spend their BTC, or there would be a problem.

Unless you are a jeweler, gold and silver aren't really capital in this sense.  They are money, which can be used to buy the capital.

Sorry, but you are just totally wrong.  You are using a static view, which won't work.  In the real world, the lender will spend at least one dollar back into circulation in order to capture the value that they earned through the loan, and when they do, the borrower can acquire it and make the final repayment.  If the lender fails to do this, then the dollars don't generally circulate, and they will have no value, which would make the loan pointless in the first place.

For people seriously interested in this subject, Steve Keen (http://www.debtdeflation.com/blogs/research/) has done a lot of work on dynamic nonlinear economics.  Read some of his papers and watch some of his videos.  He'll fix you right up if you pay attention.  At least a couple of his videos cover this topic in great detail.  He shows that it is very possible to have a functioning economy (including a loan market with interest) with a fixed amount of currency.

Steve Keen is an embarrassment.  He is a joke.  He wants the government to give a debt jubilee to deadbeats in debt.

Fractional reserve lending is nothing more than a fancy name of stealing your money.  Get your money out of the bank asap.

While you can disagree with his proposed solutions for the debt-crisis, that does not take away his awesome work in explaining the current system of 'lending before reserves' and similar topics. I can be thousands of persons, combined in one single physical body. Let's approach Keen's work the same way - on its merits.

+1

I'm not a big fan of Steve's political views either, but his dynamic approach to economics is fucking fantastic.

One easy to ignor aspect: Although there are only 100$ in existence, they can change hands many times, each time it changes hands, some goods change hand and get consumed (MV=PY)

Same when talking about fractional reserve banking: "With 10% reserve requirement, 100$ could create 1000$ loan after many times of deposit and loan process"

This 1000$ is very misleading, it is just a count of the same money multiple times in different time, the total available money at any given moment is always 100$

why?

I am aware that the lender will spend some money back into the economy which might end up in the borrower's bank account as profit. Assuming 20 mil BTC is the total amount of BTC in existence, in your example, the lender will have to buy 10 mil BTC worth of good and services from that country so that in the end, the lender gets 30 mil BTCs as 20 mil in coins + 10 mil in the form of good and services. Right?

Well, I'm not sure that is the perception that many people have when making a loan. If you give a loan for $1000 with 10% interest, you expect to get $1100 after a (long) period of time, not to get $1000 + a $100 voucher worth of goods and services. I'm not saying that we shouldn't go back to the "voucher" system when money are backed by good and services, maybe that would be one of the fixes ...


Because it will help production companies to create more/better goods and services that are required by a growing population and/or more competitive business landscape. Already sparred on the subject. Are you asking this because you think growth is bad?

Will take a look.

The real issue arises when the money loaned is magiced out of nowhere. If I have $100, loan you that, get $110 back, that's one thing. If I don't have $100 but magic it from nowhere, lend it to you, get $110 back, I have obtained $10 for nothing. That is what the government/federal reserve is up to at the moment and it's a problem.

He asked it to make you rethink your perspectives.  Your understanding of the role of credit is somewhat skewed.  Not really wrong, but disconnected.  It's not credit or liquidity that leads to the outcome that you seem to believe above, it's reallocation of real capital that can occur using credit as a tool.  This is not a certain outcome, as it's subject to the errors of investment and adds another; namely the possibility of mis-allocation of capital.  If you want to understand why bitcoin is the way it is, one must understand Austrian Economic theory.  If Austrian Economic theory is wrong, Bitcoin will fail.  If Austrian Economic theory is correct (or more accurate than other theories) Bitcoin will persist and likely continue to grow.  Even that isn't certain.

In reality, I do not want those $1000 principle and $100 back quickly, I want borrower to pay very little principle and interest $100 to me every year, so that I can spend those $100 as I wish, and the borrower will work to earn back that $100 I spend, and pay back interest to me next year, etc...

In this way, the actual interest income will be more than $1000 for a long term loan, but there will never be $2000 existed at any given moment in the system

Oh look, another thread where we can discuss bitcoin's fatal flaw:
I can't counterfeit it.

Please contribute with something or post your wise a$$ comments elsewhere. Nobody likes a troll.


Thanks, that makes a lot of sense and to be frank, the whole post has been done from a devil's advocate perspective. I had someone asked me that question (how can Bitcoin work if you can't get credit/loan to grow) and I couldn't answer and I wish I would have a good answer to defend Bitcoin. I was hoping to start a discussion where I could find answers on the subject.

Then why not just present your question in that way?  Instead you come in here and act like so many trolls before you.  Don't you realize...

Nobody likes a troll.

He's got a point.

Look, "credit" is just someone else's saved money. If you want capital creation out of thin air, then that is counterfeiting. If you just want credit, that's not a problem. There are already Bitcoin banks which give credit. I'm an investor in one. My BTC is out there, making people money. Until GLBSE shut down, it was making me money at the same time.

There is no big difference between credit from today's saving or credit from tomorrow's saving. The later gives people a feeling that those money are created out of thin air, since currently there are nothing connected to those credit, but if the future is close and sure enough, the difference can be ignored

A short term loan is almost as good as saving, but a long term loan should be very difficult to get, since the risk of future must be factored in, this is not the case in today's credit market, banks try to get everyone a long term loan and collect interest forever, and when the situation changes, they all screwed

What you have described is the problem associated with the mis-allocation of tomorrow's capital.

Try driving a car down a road you have never traveled, you constantly need to adjust for obstacles and unanticipated events as and when they happen.  Now drive the same car down that same road, but don't steer from the present but pre-program today when and how to steer and break. Even if you can anticipate all the stops turns (not possible), you can't anticipate the kid running out into the road.

The bottom line is the future isn't predetermined; there is climate change, technological innovation and population size, all with unpredictable results. Make the wrong investment today with the futures capital "the thin air" and humanity pays the price down the line.


@johnyj MoonShadow position in mis-allocation of capital is the only logical outcome. The difference is today's savings are for tomorrows unanticipated outcomes, erode tomorrows savings today and today's savings are worthless tomorrow.

Investment should come from savings, not credit of a bank. 

Today every company has cash on the books.  You pay an inflation tax.  To replace the same equipment it costs more, an inflation tax.  When the stock rises you pay capital gains on the inflation. 

If the cash on the books increased with deflation, the company could install better capital faster and give bigger dividends to shareholders. 

Steve Keen GFY. 

Very well said!

I guess the only counter argument is that a $ today is worth more than a $ in the future (the first thing they teach you in economics schools). In other words if I want to start a project today and I can either a) borrow the money or b) save for 1 year ... if I choose a) and assuming the project's return rate is greater than whatever interest I need to pay on the loan, I will be better off by starting the project today and not delaying for one year.

However, not everything goes well with all the projects and growing with credit borrowed from future savings doesn't always end well (aka look around in Europe, U.S., etc.). Or like Adrian put it:

Yes. Borrowing exposes you to quite a lot of risk. Unfortunately, those making the decisions typically a)Have an ego the size of the titanic and don't believe that anything could possibly go wrong and b)are somewhat shielded from the outcome of bad outcomes of their decisions.

There can be no lender of last resort with bitcoin. The banks running fractional reserve schemes would have to fear bank runs and buy insurance and earn the trust of their customers.

In addition: bitcoin has low transaction cost (as opposed to gold) and the reason why people started using "receipts for gold" as money instead of the gold itself was lower transaction costs.

Why would a customer accept the third party risk of depositing his BTC in a bank and then using the receipt as money if the BTC itself is just as cheap to store and transact? Why would anyone accept such a receipt at full value?

One of the traditional businesses of banking is lending. This is entirely possible with bitcoin, but it's different than fractional reserve banking: the customer depositing the money is fully aware that it's being lent out at interest and there is a risk associated with that. There are no receipts that are used as money and if there were, they would be valued lower in the market than the BTC they are for because of the associated risk.

This is a fair question, but that does not make it impossible for fractional reserve lending to rise up among the Bitcoin economy, if the public or market demand it.  As has been already noted, a great many people are under the impression that fiat currencies are somehow superior to the gold standard, and by extention any other form of sound monetary system.  So in a bitcoin dominated world, there is nothing to prevent some minor nation from pegging their currency to a reserve of bitcoins, and then permitting their banks fractional lending supported by their taxpayers.  This would, in effect, amount to the same thing as a bitcoin bank going it alone.

Let's say some country, like greece, decides to back a new drachma with bitcoins (which it first mines and/or buys using its gold reserves) and has its state bank issue this new currency redeemable in bitcoins (1 drachma = 1 millibitcoin) and then gives power of reserve lending to commercial banks, requiring a certain reserve of bitcoins to be held by the commercial banks in an account at that state bank. The idea being that by manipulating the required reserve ratio the government can "regulate the economy" by effectively controlling the money supply to help avoid "booms and busts" and "support growth".

Why would they do that (apart from that idea of being able to regulate the economy, which is a farce in my mind).

What would happen? Would the market prefer to hold 1 drachma or 1 millibitcoin?

I say there will be a run on the bank at some point (once they have lowered the reserve requirements sufficiently on pressure by politicians who argue this needs to be done to help the economy and create jobs) and everyone will want to redeem their drachma for bitcoins, and/or: there will be some Nixonesque event where some Papadimitriou will tell the people of greece that the "bitcoin window is now closed" and to "keep using the drachma", which is "the sole currency in greece allowed to be accepted for payment of debt and taxes". -> failure of the idea to make bitcoin backed currency with fractional lending and probably also failure of greek economy.

I don't contest your predictions, but that doesn't change the likelyhood of some entity trying somehting alng these lines, nor does anything in Bitcoin actually inhibit such an action.

It's not in theirs, though, which is why they would do it. The lure of "We can get it right this time." is strong.

true.

I think they might know it's a farce, just an excuse to be able to print/spend more money and control the people.

That's the scary thing. They actually believe this crazy shit.

I read a book a long while ago about some systems theory stuff. The author reported on some experiments with a software he wrote... a simulation of a small kingdom in Afrika or something. Groups of contestant were given the job of the king and they should try to make it good for the inhabitants. They were able to change some values and they all fucked up badly.

Another experiment was even simpler: A simulation of a cold storage. The goal was to keep the cold storage at a temperatur of -20 °C, they had a controller knob and temperatur display and were told that lower knob setting meant lower temperature. Nothing fancy in the simulation, just some latency as a cold storage would usually have. Only a small percentage of participants (I don't remember exaclty, maybe 20% or 30%) managed to get the temp under control within the reasonable time they had to accomplish this.

This leads me to think that it's extremely naive to believe "controlling/steering/regulating" something as complex as the economy of a country or even the world could be successfully accomplished by a group of people, however smart, educated and well-meaning they might be.

I think it could be done if there was some complex emergent system where the better people were at controlling resources the more they were able to control....

Oh, it is. And that's a conclusion any sane person would come to after having read those studies, or possibly even having read of them. But how many politicians read those sorts of things? They don't even read the bills they pass.

What it boils down to is they're either idiots, or evil. I prefer to think of them as idiots, since that allows me to seek a peaceful solution.

...hmm, something like a market economy based on sound money?

Nah. That would never work. We need to let the machine elves make all our decisions for us.

..wrong thread? ;)

I think this thread should at this point be merged with the "Resource Based Economy" thread ;)

Entitle the new thread "Moot Points You Should Never Start a Topic About Here because They Have Already Been Debunked Ad Nauseum"

It should be noted that I've successfully turned it from a conversation about Zeitgeist Communism into a conversation about Free-market Economics.

http://i0.kym-cdn.com/photos/images/original/000/162/317/2vA1a.png

haha! noted.

IMO, Fractional Reserve Banking just works like insurance: 99.99% of the time the saving account will not get a withdraw before the contracted deposit time ends. Since these money are dead money before the deposit period ends, banks try to get some use of it by loaning them out, there is nothing wrong

The problem is that they loan these money out to buy a house, instead of investing in some future projects that could possibly generate some return

The return of buying a house is purely dependant on the house value, it is more like a speculation, it is not sustainable. The investment on future projects are more carefully considered by some experienced entrepreneur and are more likely to generate some return

Another problem is that currently there are really less and less investment opportunities, buying a house becomes an outstanding investment opportunity

Loaning out money to people to buy a house is a big deal, it quickly depleted the savings in the bank, and when house price falls, these loans will generate loss, banks have high risk of going bankrupt, currently they could only depend on FED buying their mortgage backed serurities to keep their life, but this situation will not improve until the savings in bank return to normal. During the next 10 years, there will be more and more savings deposit mature, and there will be less saving go into bank, banks have to borrow money from central bank to buy more time

All these has nothing to do with fiat or BTC, in a BTC bank, FRB could also happen, exactly the same

If only everybody could be convinced of this conclusion we would have finally caught up to what von Mises figured out in 1920.

http://en.wikipedia.org/wiki/Economic_calculation_problem (http://en.wikipedia.org/wiki/Economic_calculation_problem)

Not true. Your home is not an investment (unless you are a dullard). Your home is the place where you live. You can choose to rent or buy. The return on lending the money for a home does not depend on the value of the property but on the income of the borrower. When I was paying the mortgage on my house, the value could have dropped hugely yet I would have continued to pay. It's the idiots who borrow (and the idiots who lend) more than can afford to be paid back that are the problem.

As stated before, if there were a market for such instruments they could be done with bitcoin. If you wanted you could even do exotic things like credit default swaps. But who would want such crap.?

I don't think so, because: BTC Banks cannot borrow Bitcoin from a central bank to buy more time.

award for most concise analysis!

True, no last lender means they have a bankrun risk, so that they should treat each loan much more carefully. This is by design

The return on lending the money for a home depend on the FUTURE income of the borrower. In a society that computer and machine continuously replace people and all the low tech work outsourced to other country, how could you make sure the future income is secured for the home buyer? That FUTURE is not one or two months, it is 20 years or more, who can see that far?

Completely true. My point is simply that the return on a house loan is not dependent on the future price of the house.

Exactly. If loans can still theoretically be made and fractional reserve banking and interest can still be part of the loaning process, the fact that there is no last lender and the fact that it is a well know fact that there is a known total maximum amount of coins make banks run risks very high.

I still have a question on loans as a way of generating credit. Will there be an interest in BTC loans? I know interest can be regarded as a measure of risk and as a measure of inflation protection. With a deflationary currency, how would interest be calculated? I.e. - this project has low risk of 4% and BTC appreciates on average 5% per year ... therefore your loan interest will be -1%?!

It makes them higher than what you're used to, that does not make such risk "high".  A bitcoin bank that fractionally loans out twice as much as it keeps in reserves can crediblely do so, so long as it's open and up front abou it's methods and long term CD's are it's primary method of raising capital (or some other not-on-demand deposit system).

Almost certainly.  There have always been interest in investment loans.


You're guessing, and poorly.  Keep thinking and you might get there on your own.

Except that the bank can't lend out bitcoins, but only something that can be redeemed for bitcoins. Would you accept a piece of paper that says: "can be redeemed for 1 Bitcoin at the first international bank of bitcoin at any time" instead of 1 Bitcoin?

I wouldn't.

The circumstance that made fractional reserve banking possible historically was the fact that such "receipt money" was already being used for other reasons (gold too hard to store, carry around, cumbersome to transact, divide up)

With bitcoin, how would this happen? Transaction, storage cost and ease of handling of the "base metal" (bitcoin) is already very low and its divisibility high.

Does anyone feel the urge or need to bring his bitcoins to the goldsmith for safekeeping?

Again: I'm not saying it's impossible: I'm just saying I don't see any chain of developments that would make it happen.

Ah, ther is the rub.  You don't see it.  I most certainly do.  Investment banking is different than what you are used to.  That said, what if WalMart or Amazon started a bitcoin fractional bank?  Certaily some would distrust either of them, others would respect the honestly.

You've got it backwards.  The borrower gets actual real bitcoins.  It is the depositor that gets the IOU.

I know the example is a poor one because you can just sit on your bitcoins and get the 5% appreciation with 0 risk involved;, but I chose it to show that the current way of thinking about interest on loans does not apply to a deflationary currency.

So basically, nobody will loan money to low risk projects?

Hm, I might've caught a glimpse of what you see. Can you explain in a little more detail how that Amazon fractional bank would operate to help me get a clearer picture?

So the depositor isn't expected to use the IOU as money and it's usually not transferrable to a third part, it's just his account balance at the bank? He is still told he can withdraw all his funds at any time?

I guess I was confusing some things. What I was talking about was a bank actually making a currency backed by bitcoin and giving out more of that currency than it has bitcoin to back them with. I guess that's not fractional reserve lending at all.

The point someone else brought up, namely the risk of bank runs due to the lack of a lender of last resort is still valid, though.

Sounds like you are finally starting to understand what some people here are talking about when they mention fractional reserve.

Pretending I run a bank as an example:

Over time 3,000 customers have all deposited money with my bank.  For the sake of this example lets assume that each customer has 100 BTC on deposit.  My bank has in cold storage a total of 300,000 BTC set aside "reserved" for the purposes of honoring withdrawn funds or other debits against customer accounts.  When one of my customers makes a payment to another of my customers, I don't even have to create a blockchain transaction for the transfer.  I simply update the two accounts in my bank database.  I only have to pull from the reserve and send across the blockchain if one of my customers is transferring value to somewhere outside my bank.

Now, I come to realize that with some customers making deposits while other customers are witdrawing, my cold storage never seems to drop below 100,000 BTC.  So I loan out 10,000 BTC from my reserve to someone I have determined has a high likelihood of repaying the loan.  I still have 290,000 BTC in reserve today, and am confident that my reserve won't drop below 90,000 BTC through normal business.  I now only have a fraction of my depositors funds in reserve.  Any one customer could close out his account at any time and still be paid his full 100 BTC at any time.  For that matter, most of my customers could withdraw all their bitcoin at any time, and I'd still have enough in reserve to honor those debits.  So long as I continued to provid value to my customers and thereby gain additional customers to replace the ones who have left, there won't be a problem.

Of course if too many of my customers loose faith in my bank and all try to withdraw all their funds at once, I will obviously eventually run in to a problem where I can't honor the last 10,000 BTC of debits.  If my bank is insured by someone else who is willing to take on that risk for a small fee, then the insurer will have to pay off the last 10,000 BTC to my customers and take the loss against all the fees from all the banks they insure.  Most likely, the insurer will at that time also take ownership of the loan and become the payee, further reducing their losses as the debtor continues to pay back the 10,000 BTC plus interest.

As you can see, the person receiving the loan from the bank gets "actual" BTC.  The account holders at the bank receive (or send) "actual" BTC whenever they make transfers out of the bank.  The "IOU" is shared among all the accounts on a fractional basis that increases as money leaves the bank, and decreases as the bank takes in more funds.  Ultimately the insurer pays off the IOU from the profits they acquire from the insurance premiums collected from banks that have not failed across the entire banking industry.

Regardless, while there is still only a total of 300,000 "actual" BTC in existence withing my banking system at the time of the loan, an additional 10,000 BTC has entered circulation "out of thin air".  As all my customers still have their full balances showing in their accounts totaling 300,000, but 10,000 of it has re-entered circulation in the hands of my debtor.

The smaller the fraction of account balances that I hold in reserve, the higher the chance that customers will loose faith in my bank and I'll have to turn to my insurer to make my customers whole.

Danny did a fine job on that front.  The question then becomes, how strong of an institution would you consider Amazon to be?  How conservative their lending practices?  The root problem with central banking isn't fractional reserve lending practices per se, but the small amount of reserve the banks are obligated to maintain, since central banking isn't a free market and pretends to insure itself.  When the banking system is ultimately supported by taxpayers, in the form of cheap insurance, they tend to push the rational limits of the 'fractional' part, favoring profit over risk.  An independent banking system, subject to the forces of the free market, might still operate in a fractional manner but not nearly to the same degree due to the risks involved.

Yes, that is still valid, and it was exactly how the 'wild' banks in Hong Kong would keep each other honest right up until the start of WWII.  If one of the banks took things too far, the other bank owners would get wind of it, and start to amass their "notes" (if they printed any, which they did in Hong Kong, usually on recycled newspaper) and if they thought that they had enough, might start a rumor of a bank run, and actually send agents with mass numbers of notes to demand gold in person.  This is what maintained the honor among thieves in the past, and it could do so again under a free market version of bitcoin dominated fractional reserve banking.

No, this is a common misconception about fractional reserve banking. R.A.Heinlein used this mistaken in one of his books and I myself believe that to be the case for a while.

FRB doesn't mean a bank can lend out more than it has on its books as deposit, only that it has to actually keep a fraction of it and can lend out the rest. Of course, the government, through the Fed (I believe) can create money to lend to the banks at crazy low interest rates so in some ways it amounts to the same. This would not be possible with Bitcoin, of course.

This is an excellent description of banking.

If someone wants to understand modern dollar banking, this is a good starting point, just replace BTC with USD in your head as you read it, and that brings you up to around 1913.  There have been two "innovations" since then that work as a team to entirely eradicate bank runs.  The first is the Federal Reserve System which can create money at will, in any quantity whatsoever, and lend it to a bank facing a run.  The second is FDIC.  Since money is imaginary anyway, there is no reason to allow a depositor to lose any because of bank mismanagement or whatever.

I'm skeptical about this story. You are saying that banks would loan money to their competitor and then start a bank run to cause the bank to fail? That seems like a losing strategy. Not only do they lose their own money, but the customers that they would get from one less competitor would  lose their money, too.

Anyway, lender of last resort apparently doesn't do a very good job of preventing bank runs. The Federal Reserve was a lender of last resort during the depression and there were plenty of bank runs. Deposit insurance (FDIC) was created to prevent bank runs. An interesting thing to note is that deposit insurance promotes risky lending by banks, making it more important to have a lender of last resort to bail out the bank.

They keep each other honest by calling each other on their bluffs. Anybody who bluffs too hard, loses out.

A passage from Cryptonomicon (http://www.cryptonomicon.com/text.html) (That, uhh... seems to be the entire text. Don't nobody sue me for linking to it) comes to mind....

No, the banks of Hong Kong issued warehouse receipt notes for gold, and these traded on par with each other based up the claim of gold weight printed upon them.  All of the banks issued more such warehouse receipts than they had gold to cover at any one time, and all of the other bankers knew it as well.  If one was taking things too far, he would also be driving down the interest rates; thus the profits of the other banks.  so the others would accumulate the warehouse receipts of the offending bank until they had enough of them that it was unlikely that the bank would be able to honor them all at once, and start a run.  Thus running the offending banker out of business.  It was called "wildcat" banking when it was the norm in the US from 1860 or so to 1890.  It was also known as the "Free Banking Era".


Deposit insurance is an illusion anyway, but yes, it does contribute to a circular justification.

This is the part I don't understand. By "accumulate", I assume you mean "pay money for", and I assume the result of starting a run is that the value of the warehouse receipts goes to 0. So, the tactic was: pay for a whole bunch of warehouse receipts and then make them worthless, right?

@DannyHamilton: Thanks a lot dude, for your great example.

Thanks to you guys explanations I think I have a picture of how things worked in the "free banking era" and it doesn't seem too bad to me, because banks have an incentive not do "overdo it" on their fractional reserve ratio.

What we have nowadays, though, is a bit different, right? Fiat currency isn't backed by gold and can be created at commercial banks by a magical process called credit creation (or "credit expansion"?): the bank puts a new loan into its books as an asset and at the same time increases the balance of the customers account who took the loan by the amount of the loan. New money has been created. The bank cannot do this indefinitely, though, it need some "other assets" to back up the loans. Is that correct? How exactly does this work?

No, because the banker starting the run rumors would be first in line.  It's the depositors who heard of it late that end up screwed, and angry.  It's never the bankers you see in a mob.

A bit over simple, but yes.

Simple is good, as long as it allows to draw correct conclusions ;>.

What kind of assets are required for a bank to have as reserves for the credit creation?

A couple of comments on the IOUs, warehouse receipts, customer deposits and loans in a BTC economy.

First. With the current system, the IOU that you get from the bank is indistinguishable from the currency. Say you deposit 100 USD in BoA account, the bank will show that you have 100 USD, not 100 BoAD that are redeemable 1 on 1 with USD. So, that's a big difference because that will mean we need another form of currency to make BTC currency work, right? Name it banks' IOUs, vouchers, litecoins, etc.

Second. There is no such thing as customer deposits and loans with BTC because BTC is built for transactions; you cannot "deposit" in a BTC bank because it's not like you will share the private key of your account with them or they will share it with you and you can check your BTC account from time to time. You will "buy" an IOU from the bank that says you can get 1 on 1 BTCs for it (like the current system). So we go back to the first point.

I still don't understand how a loans with interest system will work in a BTC based economy. Knowing that BTC can not be created by banks via "credit expansion" and that there is a limited number of them in existence, how will the interest be paid back? With what BTCs?

Simple: produce something useful (or provide services), earn BTC and repay your loan with BTC. The closed system of BTC does not block parties from using interest.

In our current system?  Banks are supposed to keep a 1:9 reserve to lending ratio, in other words banks are permitted to lend out nine times as much as they have on their books.  However, this includes not only the CD's and savings account balances, but also the marked-to-market value of all the collateral used in all of the loans.  I.E. the resale value of the cars and homes themselves that the bank would 'repossess' should the borrower fail to honor the terms of the loans.  So the ratio of cash on deposit to debt outstanding can be much higher, and when Lehman Brothers failed their real reserve ratio was pushing 1:50.  Reserves can be anything with an established market value; gold, foreign currencies, even raw land.

No we wouldn't need such an alternative currency, but one could exist. 


No, you're getting confused.  We already have rudimentary banks, in the form of online wallet services.  Imagine if one particular service, let's call it BitcoinPal, were to grow large enough that it had thousands of consumers & retail websites with accounts.  Whenever a consumer used his web portal or smartphone app to import the address of a member's retail website, the computer doing the action could recognize that address to belong to a member, and simply credit that member's account.  This would require group storage of bitcoins, like a bank does with cash, and thus there would be some currently unmet need that the bank can provide that is costly to an individual consumer.  Most likely this would be transaction fee reduction, as thousands of members could operate in this way (so long as the banking institution was trusted) and only produce a blockchain bound transaction. Such transactions are cheap now, but they are subject to market forces too.  When Bitcoin is seving as many transactions per second as Visa, we can't expect a transaction fee to still be a nickel.


Ah, I see the block. You belive that successful banks would eventually own all the bitcoins, correct?  Well the free market doesn't work that way, those bitcoins, including the interest, is always in motion.  Banks pay employees, employees buy services, businesses pay their loans; and when they don't, loans default and banks lose both the principal and interest on that loan, and the interest on a couple others to balance out the loss of reserves.  Interest rates would naturally trend down toward a point that is close to the default rate plus the dispersion rate.  Very unlike our current system of fixed rates.

I realize you like to refer to bank accounts as IOUs, but as far as I can tell, the bank doesn't issue me a voucher.  They store a number in a database (or prior to computers, on a ledger) that indicates how much of my USD they are holding for me.  When I engage in a transaction, it is the value of that USD that is transferred.  Where it is transferred depends on the transaction.  If I transact with someone who uses the same bank, all they have to do is transfer the value from my database entry to the other customer's database entry within the bank.  None of the originally deposited USD needs to be moved.  On the other hand, if I choose to withdraw some of the USD that I have on deposit, then they give me USD, not BoAD.  This comes out of the total USD they have on deposit. I don't see how this requires another form of currency to make BTC work.  It should work pretty much the same way.

It is difficult to predict how an industry that doesn't even exist yet will operate, but my assumption is that you will transfer control of the BTC value to the bank just like you transfer control of the USD to them when you deposit them.  Nobody needs to share private keys.  You will transfer your bitcoin to an address the bank owns, and they will place an entry into their database indicating that they are holding a certain amount of your bitcoin for you.  When you engage in a transaction with another customer of the same bank, they won't move the bitcoin at all, they will just update the two database records in their computer system (just like with USD).  When you choose to withdraw some BTC, you will provide the bank with a Bitcoin Address, and they will transfer the amount you wish to withdraw over the blockchain to you updating their own database to reflect the reduced balance they are holding for you.  This too seems to work the same way as the current personal banking system.

I'm not sure what confuses you about the process.  You receive a loan, you make payments on it out of your income until you've paid the balance off.  You've reduced your purchasing power a bit, but made your purchase sooner gaining the benefits that come with earlier ownership of whatever it is you chose to purchase.  The lender has lost use of their currency for a time, but now has more purchasing power.  Both parties are satisfied with the transaction.

To answer your question, laws limit the amount of deposited money that a bank can loan. The limit depend on the quality and size of the deposits. It is called the "reserve requirement" and it is set by the Fed in the U.S.

Fractional reserve banking (FRB) works whether or not the currency is backed by anything. In a nutshell, it works like this: I deposit $100 cash in a bank. The bank loans $90 of that to someone else. I believe that I have $100 in the bank, and someone else has $90. The perceived amount of money is now $190, although the actual amount is still $100. That's how FRB works. There is no reason why bitcoin can't have fractional reserve banking.

What confuses me is that if I apply simple mathematics, there is no way for the system to work. You can't pay back $101 (principal + 1% interest) if there are only $100 in existence. With BTC this is obvious because there will only be a maximum 21 million in existence and no other way to create them. It's a zero sum game. For me to repay the extra $1 is for others to "lose" that $1.

I guess moon hinted already in his/her response. Any interest based loans system (currency being fiat, BTC, whatever) is built for or is based on defaults. For the system to work, someone has to default at some point.

You're forgetting the possiblity of defaults.

Another option: Loans can be rolled over.

What about bonds (securitized loans if I understand correctly)?

You are correct for your particular scenario; however, just because your scenario can't work, it doesn't mean that no scenario can work. In fact, if you loaned me all the BTC in existence, I could still pay you back all that (plus more) over time as long as neither of us hoard all of our BTC.

Your zero sum game assumes that productivity is 0, but it isn't. To repay that extra $1, I could catch a fish and sell it to someone for $1 and nobody loses anything.

Bonds are just a form of private loan, wherein some company (or other institution, such as a city government) needs to raise their cash position.  Normally, bonds are a one-for-one exchange, no fraction involved.  Investment banks will often issue bonds to be sold, so that they can raise their reserve fund high enough to grant a huge construction loan without breaking the reserve ratio required by law.  This is what is supposed to happen, but it doesn't always.  Bonds are unsecured revolving credit for huge institutions in a similar fashion that credit cards are for consumers.  Bonds function much like an old fashioned bank CD,  in the sense that bonds don't pay out on demand unless you're willing to sell them for a discount on the secondary bond markets.  Utility bonds are some of the safest places to store fiat currency in any of the first world economies, but really all they are is storage.  You're lucky to keep up with inflation under normal circumstances and you certain won't right now.  But even utility bonds sometimes go bad.  Municipal bonds, IMHO, are riskier than utility bonds mostly because you have a group of polititians trying to make a sound judgement on whether or not they can repay the costs of constructing that new sewer system with the tax base.  So you have a group of people who salary is not dependent upon their economic prowess, deciding upon a debt to be paid back by taxes, the amount of which is not often related to the success of the project it's funding.  Whereas a utility bond is pretty straight forward, you're loaning money to a company that (for example) builds power plants with the expectation selling the power from those plants to the city and it's people. 

Lets work with your VERY SIMPLIFIED example of only 100 units available and one person has all of them.

There are only 3 people in the world, Bobitza, Lisa, and Danny.  There are only 100 units of currency in the world, and somehow Bobitza has managed to acquire all of it. Bobitza has deposited this currency in a bank owned by Lisa.

Bobiza has no fishing skills at all, but loves to eat fish and owns a shop that sells fishing equipment.  Danny is an amazing fisherman, but his fishing equipment is now broken and since he has none of the currency, he is unable to purchase any of the fishing equipment from Bobitza. This means that neither Danny nor Bobitza will be able to eat and will therefore starve.

Danny goes to Lisa's bank and informs her that he'd like to borrow 100 units of currency so he can purchase some fishing equipment.  He will be paying her back 110 units over the next 11 weeks (10 units per week).  Lisa knows of Danny's fishing skills and judges him to have a low risk of default.  She also knows (for some reason) that Bobitza won't be withdrawing any units from the bank this week, and won't be withdrawing more than 10 units per week in any of the following weeks. She lends him the 100 units out of the bank.

Danny takes his 100 units of currency to Bobitza's fishing equipment business and purchases all the fishing equipment he needs.  Bobitza takes this 100 units and deposits them in Lisa'a bank.  He's a bit confused, because he thought that he already owned all the units in existence, but he is glad that he now owns twice as much as he did before. Lisa breath's a sigh of relief when Bobitza deposits the 100 units because she now has some currency on hand in case Bobitza decideds to withdraw some.  Bobitza's account at the bank indicates he has 200 units on deposit and Lisa has 100 units in reserve so she is engaging in fractional reserve lending.  

Danny then proceeds to catch fish to eat and sells the extra fish to Bobitza who loves fish so much.  Each week, Bobitza withdraws 10 units of currency from Lisa's bank to pay Danny for his fish.  Danny then heads straight to Lisa's bank and makes a 10 unit payment on the loan which Lisa adds back to the bank's reserves to cover any additional currency Bobitza might decide to withdraw. Lisa feels more and more comfortable about her reserve situation each week as the number of units reflected in Bobitza's account drops by another 10 units bringing it closer to the actual amount she has in reserve.  Meanwhile her reserve remains at 100 units since Danny keeps making his loan payments of 10 units.

So, in the tenth week, Bobitza has payed Danny 100 units of currency for the fish bringing his balance back to 100 units and Danny has paid Lisa back 100 units of currency so the bank still has 100 in reserve.  At this point Lisa is no longer engaging in fractional reserve banking since the 100 units she has fully account for the 100 units that Bobitza's account indicates.

Now the 11th week comes along and Danny sells another 10 currency units of fish to Bobitza which he uses to pay off his final loan payment to Lisa.  Bobitza's account now indicates that he has 90 units. Danny no longer owes anything, and Lisa's bank has 90 units in reserve for Bobitza as well as 10 units of profit from the loan.

Does this explain how it works, or am I missing something?

Not really, it's just flexible in another place.  Fiat currencies are 'flexible' in the sense that the absolute number of monetary units (the total monetary base) is not fixed, and therefore the issuing entity (in theory) can add or witdraw (ha, ha) currency as it sees fit to maintain "price stability".  This makes the assumtion that price stability is desirable, but there is no economic reason that this is so.  Hard currencies, like Bitcoin or gold, have a fixed monetary base so they are "flexible" at the price point; which is one reason that the market exchange rate of bitcoin moves so much relative to fiat currencies and can be expected to do so for some time.

While parrallel clones of the bitcoin system could lead to expansion of the monetary base in theory, I don't think that's what is going to happen in practice.  A competing cryptocurrecy has to offer an advantage over bitcoin in some fashion or another in order to establish a market value at all.  This could be done by a niche need, such as with Namecoin; or it could be done by the promises of a trusted entity, such as WalMartCoin or AmazonCoin; or it could simply be that a clone fixes an as-yet-unknown bitcoin flaw (that is otherwise unfixable within bitcoin itself).  But without some obvious advantage in a particular market or function, bitcoin clones will never do well if they have to compete alongside bitcoin, because bitcoin has the first-to-market advantage and new vendors will desire to use the most widely known cryptocurrency first while most new digital consumers are going to desire the most widely accepted cryptocurrency as well. 

Yes, it could; and the size limit on the bitcoin block is arbitrary and amendable.  It's generally assumed that the max-blocksize will be increased several orders of magnitude in the future; but never permitted to be unlimited.  This forces a premium on transactions that need to be processed quickly if there the network is close to the limit.  In prior threads on this very topic, a max-blocksize limit of 1 Gbyte is likely to be the high end in a distant future wherein Bitcoin is processing more transactions per second than Visa while remaining within the practial limits of bandwidth that a dedicated server can afford, assuming that the costs of bandwidth do not continue to drop, which is also unlikely.

a normal functioning economy grows at 1.5% to 3% per year

By what logic to you come to such a conclusion?  Are you basing this off of population growth, or something else?

Yes, the example given does explain how loans and interest can work ... in that very scenario. Lol, couldn't help but notice that with multiple loans like that, Lisa's bank come to hold all currency and Bobitza and Danny will have 0.

Here's what you might be missing. Same scenario but Bobitza doesn't like fish and has a farm that provides enough food for him and his wife Lisa. Unless Lisa accepts 10 units worth of fish in the 11th week, Danny can't make the final payment. Sorry but I can't get over the fact that 101 != 100.

I understand that money will circulate and the borrower will sell products indirectly to the loaner thus making somehow the interest payments possible because people don't hoard the currency. And with a few loans, that is going to work. However the more loans are made, the more interest payments will become a bigger part of the whole money supply and for example, at some point in time, all the money in existence will become interest payments. I still think somebody has to default to erase some of that interests payments that are now banks profits.

And speaking of "the people don't hoard the currency" pre-requisite ... what was the percentage of Bitcoins being hoarded? 78%?


I do share the view that multiple currencies can be the solution. In fact I shared a link to the Digital coin video (http://www.digitalcoin.info/Digital_Coin_Introduction.html) that touches upon this subject ... was hoping to get some comments from the people here.

But then, we acknowledge the fact that Bitcoin on its own can't be the solution for a new, international currency because it needs other currencies?

You aren't making any sense. Why would this ever happen: "all the money in existence will become interest payments"? Ok, in this absurd scenario, we have fractional reserve banking, and the average interest rate is higher than the reserve requirement, and all the interest payments are all due at the same time. Can't you even come up with a plausible scenario to support your claiim?


And yet people are doing the impossible right now: borrowing BTC and repaying with interest.

If you read the Bobitza, Lisa and Danny example, just imagine Danny's fishing net broke again at the end and he had to buy a new one ... 10 times in a row. At the end, all money will belong to the bank as profits from interest payments. Next time Danny makes a loan, Bobitza will have no money to buy the fish thus Danny will have to default.

A bank is a business like any other. Its profits are not static. They flow out almost as fast as they flow in. Employees. Building maintenance. Rent. Water and Sewage. Security contracts. Banks are part of the economy they serve, not a drain upon it. The bank will not, and can not, ever own "all the money."

From above I deduct that bonds themselves do not count as reserves. Thanks for your explanation of bonds.

This is of course a question right to the point. The economy might only grow "on paper". It'd not be the economy that grows, but the money supply. Measuring the "health" of an economy by calculating GDP is totally flawed if you have an elastic money supply.

Yes, this is exactly what we are witnessing in our current system: a debt bubble.

Now as to somebody having to default: I don't think this is true. The lender of last resort can just add so many zeros to the money supply and inject the fresh money into the economy (albeit usually at the wrong place, in the financial sector). It's not mathematically impossible. However, this will at some point certainly lead to a confidence crisis of the currencies involved, because at some point the fresh money will trickle down sufficiently into the "real economy" and cause prices to skyrocket. People know the central banks are printing money and they don't see any of that money hitting their wages. It's making it impossible for them to simply "save". They will be starting to wake up to that fact once the price of butter increases by 50% within a year and their income doesn't.

That number is debatable. The paper that arrives at it has flaws.

Also: if there was a totally trustable depository, I'm pretty sure people would deposit their savings to earn interest.

btw: here's a rather tangible example of how fractional lending might occur in the bitcoin economy: Let's say mtgox decides to open up a bucket shop sister site offering leveraged trading. Let's also say it uses the BTC and USD deposited at the real market accounts to lend out for leverage. This is both pretty safe and very profitable for mtgox: after all in case of a bank run, all the money is really still there and could theoretically be taken from the bucket shop borrowers via a margin call (these borrowers did not withdraw the BTC or USD, they put them into a position in the bucket shop). All the while the BTC and USD are sitting comfortably in mtgox cold storage or traditional bank account untouched, but the "perceived" (and this is all that counts) money supply has increased (sum of account balances at mtgox plus positions on mtgox bucket shop^TM). Voila: fractional lending.

They might however, at some point, own all the real assets, like buildings, roads, companies, production plants, resource mines, gold, etc... Money is just something that needs to flow around the economy, they don't want it, they know it's worthless paper and database bits in the end.

EDIT: sorry guys for my morning-rants. I kinda desynced, you guys seem to be in a different timezone so I have to do a lot of catching up on this very refreshing troll-free informative thread that has already delivered some insights for me. ;>

My example was only offered as a way to explain how it works with your extremely unlikely and really impossible scenario that that one person owns all the units of currency and is loaning all of them out at once to a single person.  You'll notice that in the example I gave, Lisa has no need for currency for a period of 11 weeks.  In the real word this is very unlikely.

To start with, in a world with only 3 people there really isn't a need for a currency.  Assuming there are more than 3 people in the world, the Bank will need to use those profits to continue to exist.  They will need to spend them on operating expenses.  Bobitza will need to purchase more than fish.  At a minimum he will need to cover the operating expenses of his fishing supply business. He will have other people making purchases from his business, so he may not need to use funds from his bank account to pay for Danny's fish.

Your problem seems to be that you are looking at currency as a static thing.  Bobitza loans Danny 10 units, then Danny hands back 110 units all at once before any time has passed.  Money gets reused over and over as time progresses.  My example was trying to who you how it was the exact same 10 units of currency that kept moving in a circle between Bobitza, Danny, and Lisa to pay off the 110 units.  Once the loan (and purchase) was made, there was no need for there to be 100 units in existence any longer.

You are right that if a single person significantly out produces everyone else providing something of significant value to everyone, then they can and will amass a very large some of currency over time.  The effect is amplified in an example where there are only 3 people and 10% of the entire economy is being moved around on a single transaction.  Yes, if Danny has to repeatedly borrow from Lisa, and Lisa has no need to ever spend the currency (or spends significantly less then she earns in interest), then she will eventually own all the currency.  On the other hand, if Danny sells 10 currency units of fish to Lisa once and continues to supply fish to Bobitza for 9 more weeks, then Danny owns all the currency.  Of course, if Lisa and Danny both buy fishing equipment from Bobitza and he withdraws all his money from the bank, then Bobitza owns all the currency.

In reality, all these "ifs" balance out along with the millions of other people using the currency.  The money continues to flow throughout the system, and interest continues to be paid.

Here is an analogy that might be poor, but it works for me.

Assume a bowl of water with exactly 15 units of water in it.  You have a spoon (or ladle) removing 1 unit of water from the edge of the bowl. You scoop this water from as close to your right hand side of the bowl as possible.  Then you pour it out into the same bowl as close to your left hand side as possible.  How many times will you be able to perform this action before all the water piles up on the left hand side?  The problem you have is that the water continues to move over time filling in the area where you scooped it from other nearby areas and moving outward from where you dumped it to other nearby areas. So the right hand side of the bowl can continue to pay the left hand side indefinitely as much interest as needed.

Now the economy can be manipulated and individuals can suffer from that manipulation.  If all the areas near the right hand side of the bowl decided that they weren't going to give that side of the bowl any more water (essentially building a wall to prevent water flowing into that area), then eventually the right hand side would run out.  If the left hand side were to start hoarding and refuse to allow water to flow out (building another wall on the left hand side) then the left hand side would end up with more than most areas that are still participating in the economy.  But unless the left hand side is willing to spend some of that water into the economy of the bowl, it isn't going to be very useful to them.  An area in a bowl of water doesn't need to participate in the economy of the bowl to survive, but we humans generally need to participate in the economy around us for survival.

The way that Bitcoin deals with the situation of removing currency from the economy is to naturally end up using a smaller amount if bitcoin for the same type of transaction (delfation).  In the water bowl example, all of the participants end up using spoons that shrink over time getting smaller and smaller, so that they are moving ever smaller amounts of water in any given transaction.  This deals with both lost wallets (water spilled out of the bowl), and hoarding.

some would argue that it will be a problematic when the floodgates are being openend.

Certainly, but that is part of an entirely different discussion than the one I am having with Bobitza right now.  At the moment we are discussing why interest on loans in a currency with a fixed supply is able to work.  The sudden release of previously hoarded currency is an issue that is not limited to fixed supply currency.  How the market can adjust and minimize the unpleasant effects on the economy in that scenario should probably be moved to a different thread.

That's an interesting perspective. Your bank statement is basically a promisory note that the bank will redeem USD x on demand. You don't have USD x in the bank. It's not currency since it's not transferable but it's interesting to consider it that way.

That "the floodgates" will be opened is something of an assumption. Those currently holding large quantities of BTC probably have different ideas at what amounts they will sell at and even then, if individuals have any sense at all, they will release just a few medium-loads of BTC every now and then rather than all at once otherwise they could tank the price and end up taking a big "loss" (A CEO with a lot of stock options will never dump them all at once).

Not likely. All of those expenses I outlined are services, and I just scratched the surface. Yes, it's possible (theoretically) for a bank to buy up everything, but it's also in competition with every other market actor to get those things. There's a reason you can never corner the market on anything.

You have it backwards.  Or rather the banks do it backwards.

What really happens is that the bank makes a $100 loan first, and then seeks $10 in reserves.

To the bank the order does not matter, as long as the reserve is in place before the regulators take a look at their balance sheet.

Lol, interesting example you found there.

Here's a thought. For the loans+interest system to work, it has to have 100% efficiency. Meaning the bank will spend back into the economy all the interest money they collected, meaning there are no money "lost" somewhere in between, etc. Because in order to pay back interest without actually taking another loan, the money to pay back interest need to be be available somewhere in the economy, right? To use your example, one has to be very careful/fair with the spoon to not spill/pour a single drop of water on another bowl.

I don't believe the system can be 100% efficient, or in other words all interest money will be re-circulated and there are no money "lost" in the process.

In the analogy, it is all a single bowl, there is no other bowl to pour into.  Now you can spill outside the bowl, but that isn't interest, interest is still part of the economy.  Interest (or any other money) that the bank keeps is "saved" or if you prefer "hoarded" currency.  It is no different for the bank to "hoard" their money than it is for you to "hoard" yours.  It doesn't matter if that money is acquired from interest payments, or from the sale of alpaca socks.  "Hoarded" money is temporarily taken out of the economy until the hoarder eventually decides to spend it back into the economy. In the bowl analogy, hoarded money is placed in an area of the bowl that a participant has walled off.  It is still in the bowl, but it isn't allowed to flow to other areas of the bowl.  Eventually the owner may choose to spend some of the water in this area back into the generally accessible area of the bowl, or they may die without ever releasing the water back, at which time the hoarded water (currency) can be considered permanently removed from the bowl.

Water spilled out of the bowl, is currency that is lost permanently.  In bitcoin this means lost wallets.  Bitcoin that is sent to an address for which nobody owns/knows the private key. This is deflation of the currency (water) in the economy (bowl), and as such the natural market forces end up forcing the participants to use spoons (transactions) that change size proportionally with the amount of water (currency) in the bowl (economy).

Keep in mind that you have to be careful not to push the analogy to far in your mind.  The flowing of the water throughout the bowl is meant to represent the relatively random nature of the transactions that everyone in the entire economy all engage in over time.  The idea is that while some people may choose to hoard some of their currency, there is a certain amount that people will spend in their regular lives for the things they need or desire.  By using an analogy where the water (currency) flows freely throughout the system it saves us from having to come up with examples of a few million transactions between a few million people to show how the currency got from the lender back to the borrower.  In reality, water always finds its own level, and this gravitational force is what causes it to flow from where you dump it towards where you take it.  In an economy, the forces that direct the flow of currency aren't quite as evenly applied as gravity.  So those who spend significantly less than they earn will tend to have more of it over time, and those who quickly spend all that they earn will generally have none.

You seem to be stuck on the idea that there is something special or magical about interest.  Interest is simply a form of rent.  You need to think of it in the same way as you do renting a vehicle, an apartment, or a snow-blower.  Interest is simply a special name that has been created for the idea of rent that you pay when someone lets you use their money for a period of time.

If I allow you to live in an apartment valued at 10,000 BTC that I own and you pay me a 90 BTC monthly rent, then after a year you move out and return the use of the apartment to me...
How is this different from me lending you 10,000 BTC that you need to purchase an apartment for yourself and you paying me 90 BTC interest on the loan each month, only to sell the apartment to someone else after a year and pay me back my original 10,000 BTC loan?

In both cases I allowed you to use something valued at 10,000 BTC for a year, and in both cases you payed me a 1,080 BTC fee for that use.  It doesn't matter wether it was an apartment valued at 10,000 BTC, or a loan valued at 10,000 BTC. In the end I lost the use of something valuable for a year and gained 1,080 BTC, and you lost 1,080 BTC and gained use of something valuable for a year.

You just need to think of it like any other investment. You spend money, you obtain resources and you hope to be able to utilize those resources to obtain more money than you spent.

A bank is effectively partnering with another entity to form a partnership. The bank brings the money and the profits are split.

So money becomes an asset on its own rather than an exchange medium; you can make money just by having money. I understand that ... doesn't mean I agree with it, I mean look at where this approach got us into now. The power to create money should reside with people that create actual things, not with banks.

In your example, the rent I pay is the price paid for a service you're providing to me (shelter). Interest on a loan is not exactly the same; I agree to pay to the bank for their services, for managing money (aka opening account, assessing my credit worthiness, transferring money, etc.), but that should be like a fixed fee, not % of interest. I guess I'm starting to advocate for Islamic banking ... lol.

It is nearly the same.  In both cases you are compensating someone for use of something of value for a duration of time.

I would say that it matters a whole lot.  If you think that your deposit is enabling loans, and that banks can't make loans without them, you'll never understand how the system really works.

Banks don't give a fuck about your deposit.  40 years ago, if you owned the steel mill in town, sure, your small town bank might care.  That world is dead and buried.  Banks accept deposits partly out of inertia, and partly out of hope that you'll bounce a check and pay them $35 for the privilege.  Also, once upon a time, there was a meaningful difference in regulation between a deposit account and a demand account, but now through the magic of imagination they are effectively the same thing.  They call this imagination a "sweep".

In the modern world, banks just sweep up all of their deposits at the end of the day, and if they are under their reserve requirement their computer asks a computer in their local Federal Reserve district for an instant overnight loan and they pay a few millionths of a percent.  If they do that too often, or for too much, the regulators start asking questions.

Since the Fed has been bouncing on the zero-rate bound (for a while now), there isn't much point in even using the inter-bank lending process any more.  Why borrow from another bank at a few thousandths of a point interest when the fed will do it for a few millionths?  And those idiots making deposits will give it up for a few billionths, so they aren't entirely useless, but you have to wait for them to come to you, so the discount window keeps a thriving business.

* parts of this post are exaggerated or otherwise inaccurate, but it is closer to modern reality than what you remember from It's a Wonderful Life.

Don't forget, that lender didn't just magic the number from nowhere (in a sane system), it either earned it or, more typically, was lent it itself. The bank is performing a service of matching a lender with a borrower.

It may not matter from the bank's point of view which comes first, the loan or the deposit, but it does matter for the money supply. If the banks can make loans before they take deposits, then they are able to create money out of nothing, whereas if they must wait for a deposit first then there must be at least a little bit of something behind the moenetary creation.

Let's take the example of two banks, bank A and bank B. Bank A makes a loan to Bob, with no reserve, of 100$. Bob transfers that $100 to bank B. At the end of the day, bank A needs to raise their reserve, so they ask for a loan from bank B. Bank B has $100 on deposit, so they loan $50 to bank A, now both bank A and B have a 50% reserve, and the regulators are happy.

Do I have that right?

This thread may be relevant: https://bitcointalk.org/index.php?topic=79555.0 ("I used to think lending at interest was evil")

Yes, I briefly mentioned that in a previous post; interest can be seen as a measure of investment risk and a measure of protection from inflation. In the current system it's usually both because there is no 0% interest rate for risk-free assets. Care to comment on how interest should be regarded when dealing with a deflationary currency/environment? For example there can't be such thing as negative interest for risk free assets ...

I'm having trouble understanding the problem. If you view interest as a measure of protection against inflation then that doesn't make sense with a money supply that doesn't inflate, does it? Simply save (deposit money to bitcoin lending bank you trust, or: simply keep in your own wallet if 0% is enough for you, after all: prices keep falling)

If you want to enable negative interest rates, you'd have to have negative interest rates on the currency itself in order to make the negative-interest-investment look better than simple saving of the money (gesell's money, demurrage, freicoin or whatever the ideas are).

Why can't you have a negative interest rate? It might not make sense with bitcoin, but consider gold: I have 100 g of gold, but I want to keep it safe, so I give it to the bank, and pay an account fee of 1 g of gold. That would essentially be a negative interest rate. Actually, come to think of it, you could say that using a webwallet which you pay a bit of extra per transaction for the security of knowing your bitcoins are safe and availible wherever you are, that would be a negative interest rate as well. The negative interest rate is possible because you are paying to have a risk-free investment.

Paying a storage fee for a physical commodity isn't quite the same as lending at a negative nominal interest rate.

If bitcoins were gaining in purchasing power at a steady 5% per year would you lend some of yours out at a nominal rate of -1%? In purchasing power terms you'd still come out ahead by 4%, but why would you accept the risk of default to end up with less bitcoins than you would have if you had just held on to them and never risked them at all?

Say I am computer-unsavvy, or I tend to loose my computer, or it gets stolen a lot. Whatever the factors, I decide the risk of me holding my own bitcoins and losing them is higher than the risk of you defaulting. If this is true, then it does make sense to lend you the bitcoins at a negative interest rate.

That being said, I do not think it will ever come to this. My prediction is that the value of bitcoins will never rise strongly and consistently enough to justify a negative interest rate.

If you are wanting someone else to hold your money, you are not lending but storing or depositing. If, in such a circumstance, you would expect to be able to get back your bitcoins at no notice, interest would not be an issue but there would likely be some kind of fee you would have to pay for the service.

In truth, I can't see anyone ever lending at a negative interest rate. Regardless of the mathematics of the thing, you typically lend to get back more of what you're lending. Since the mathematics kinda-sorta make sense, it seems likely we are missing a piece of the puzzle.

What is the difference between giving somebody a loan or giving somebody a deposit? It is just a matter of semantics based on who is the larger party. Not all deposits are available on demand, such as CDs.

You lend to get more back than you would by just holding. Again, if just holding something is risky, the expected value might be lower than the expected value of a no-risk investment. The problem is, I do not think the risk of default will ever drop below the risk of lost coins. There are just no deposit takers who are trustworthy enough to be no-risk.

...And that's the difference. A CD has a positive interest value. You're loaning the bank an amount of money for a set time period. A demand deposit (such as a checking account) typically has fees. These fees are because while the bank holds the funds for you, they can't use them. The difference between fees and interest is that fees are typically static, while interest is dependent on the amount in the account. Would you use a bank that charged you a 3% fee, as opposed to a set fee per check or month?

If so, then you can perhaps consider that loaning at negative interest.

This whole argument seems a bit absurd since bitcoin the blockchain is itself in effect created credit and bitcoin the free open source software is a free to use credit-creation system.

Take a good look at http://galaxies.mygamesonline.org/digitalisassets.html

I think maybe no one has yet. The figures there continue to amaze me.

Something somehow does seem to have been massively suppressing bitcoin exchange rates but fortunately it maybe also has diverted attention from some of its spin-offs.

If there are not enough bitcoins to go around, or, as seems to have been the case for a year or more, bitcoin is somehow failing to represent enough value to serve as a useful unit of account, make more spin-offs.

-MarkM-

Bitcoin is completely compatible with liberal central bank directed credit creation. The bank just needs to have 51% of hashing power. Then it can charge demurrage and give the demurrage fees to banks to lend out.

Dude.  You keep posting that link like it means something to us.  It does not.  None of us have any idea what those numbers mean.

I have.  I see nothing amazing.  Care to explain what it is that I'm failing to see in the figures?


I don't really understand your point.  In what way is the blockchain created credit?

Absolutely! I think it's called "supply and demand", or "perhaps market forces".

And yet from everything I've seen so far, bitcoin has been a fine unit of account.

If someone or some organization decided tomorrow to impose demurrage via a 51% attack, the response would be:
1. What is demurrage?
2. How could I calculate it even if I cared?
3. Just wait until a miner from the remaining pools mined a block with your .001 btc fee.

The US government will always be able to print money as it desires; even if bitcoin becomes 50% of the economy, they will still be able to encourage lending via a low interest rate, as long as dollars continue to be treated as legal tender.

People can always move from dollars to btc, gold, stocks, or anything else with a more stable value than the dollar.

No, common misunderstanding. If the organization has 51%, mining must be authorized by the organization or it cannot occur.

but if the organization imposes certain rules (demurrage in this case), the 49% can just hard-fork by rejecting blocks identified as being mined be that organization.

That would set a pretty bad precedent. But the fact that it could be done would hopefully be enough to prevent some rogue entity from investing millions in the attempt.

exaclty.

I'm sorry, how do you identify the organization's blocks? By the fees they charge? That would work if you imposed a mandatory fee system rather than a market-based fee. A mandatory fee is a great idea. You have to do it now, though. You can't wait for the "attack" to happen and then try to fight the government.

Only idealistic libertarians will fight the government. The 99% will reject invalid libertarian blocks.

99% would mine blocks according to some rules that charge demurrage? I doubt it.

Of course. They would mine coins that everyone else accepted. There is no point in having money that everyone else believes is counterfeit. I'd be a little suspicious if you wanted me to download an unregistered client. That prints special money that registered clients don't recognize as valid.

We are currently printing money at about 12% per year. This is equivalent to 12% demurrage. This can be stopped of course. There is no need to accept inflation and demurrage. It is a tax on your holdings. Just create your own fork with no more block reward.

I am sure everyone will welcome freedom from the inflationary tax and rapidly accept the new coin. LOL.

Fortunately, the block validity rule is not "the first central bank to be established wins", but instead "the central bank with access to the most resources wins".
The "Axis of Evil" can rest easy at night.

Not quite.  If the miners could only get their block of currency by making a loan and waiting for the interest payments, your analogy would be better. 

If you give up the idea of fractional reserve lending then a deflationary currency makes perfect sense.

Or at least, give up on the idea that FRB is a good idea.

Plenty of currencies manage to do just terrible without any help from the federal reserve bank. Which is neither a bank nor federal.

All of them are centrally managed fractional reserve benking schemes, though.  No contrary example persists since the Europeans strongarmed the Swiss into dropping their gold standard.

Well put, but I meant "fractional reserve banking", anyway....

A person's bitcoins are only as secure as the computer system where said coins are stored.  Given the number of stolen coins from individuals and services.  It seems that a bank might be where people start looking to store their bitcoins for them.  They will charge some storage fee and usage fee to use their terminals to make transactions.  It will have to be both physically secure like a bank of today and Internet style secure at the same time.  Such a business would seem really expensive to run though.

Shawn ::)

I think hardware wallets are a better solution for securing coins against theft (as an example here the thread about slush and sticks one: https://bitcointalk.org/index.php?topic=122438.msg1317706#msg1317706) and easy to use and also easy to secure against loss.

No need to trust a bank.

The idea that currencies have to be inflationary in nature to succeed is false. Inflation robs purchasing power from savers and transfers the wealth to those given the power to create money. A tool i consider to be unjust and immoral. The world has used gold as money for thousands of years because its purchasing power cannot be inflated away by governments and banks. Gold is mined at roughly the same pace as the increase in world population. Bitcoin does one better, after the cap is reached, holders on bitcoins would see an increase in purchasing power due to their increasing scarcity.

my 2 bitcents :)

Well, not easily, anyway, and when they do, it's easy to spot, or has some significant risks, or both.

Well, you are forgetting 17th century southern Europe when Spain imported so much plundered gold from the New World that it caused widespread inflation.

And the gold rush of 1849, which caused an inflationary blip, too. But these things tend to settle out a hell of a lot faster when there's no printing press going full-speed.

It's also self-correcting somewhat. Once the price of gold falls in such a scenario, the incentive to mine/conquer more drops greatly

Correction, -  the incentive to mine more increases (motivation for innovation), but one's ability to mine more is diminished by the decrease in value (without innovation). Ones will to mine the same amount for a lower return is diminished, hence in the absence of innovation, mining more gold is diminished and the self-correcting equilibrium is restored.

You put the cart before the horse. The motivation for innovation is to reduce costs. It tends to create an increase in production which in turn suppresses prices (in a properly competitive system).

@Richy_T
I think it cuts both ways, if you have good profit (or a monopoly) you are not motivated to innovate, if you have a drive for more you are motivated to innovate, or if you have a treat of less you are motivated to innovate.

This raises an interesting questions: Is bitcoin (or something like it) the final nail in coffin of nationalism? Once everyone's using the same money... doesn't that largely remove the need for government beyond the local level?

By itself, no. 

I would hardly call bitcoin the last nail in the coffin. It is a step in the right direction, but there is plenty of other stuff in the way of peace besides just which money people are using.

Yeah, there are other reasons for nation-states more pressing than a unified currency. However, it does severely hamper that nation-state's ability to collect taxes non-voluntarily. So it's not the final nail. But it is a nail.

Deflation is a separate issue from credit creation. In a healthy economy there should be deflation. All goods should be getting cheaper relative to the money supply.

Fractional reserve banking is not necessarily inflationary. Under the gold standard there was fractional reserve banking and healthy deflation (goods became cheaper). There is nothing immoral or wrong about fractional reserve banking. The problem is the coercive monopoly (read: inefficiency) of central banking put into place by government regulation and legislation.

The Austrian School economist Steve Horwitz has a great article on fractional reserve banking here (http://www.freebanking.org/2011/06/27/the-problem-is-central-banking-not-fractional-reserve-banking/). People who criticize fractional reserve banking should read it.

As for the creating credit, that is a separate issue. Banks would either have to create their own separate currency, redeemable in Bitcoins electronically or through paper. I guess you could also deposit your Bitcoins at a bank and receive some kind of interest and then the bank invests Bitcoins in businesses for a higher return. Of course I use the word bank loosely.

There's still plenty of jingoism, regardless of the currency involved, so no.

Taken alone, this is true enough.  In practice, however, fractional reserve banking has too many flaws that can be manipulated by certain people with particular positions.  Experience tells us that any advantage that such flaws may create will be taken advantage of by someone eventually, and will continue to be taken advantage of even to the detriment of the entire system.

So while not actually evil, fractional reserve banking is certainly amoral, offering no net benefits to the populace in the long run.  The gold standard functioned as a limiting factor upon those who would have taken advantage, and thus delayed the breakdown of the system for much longer, but ultimately the breakdown still had to occur by some method or another.  Likewise, central banking delayed the greater of those flaws for some time, but at the cost of permitting such flaws to spread to the whole of the system before they are catastropic; so rather than simply a regional problem that destroys a few local banks, they become problems that grow to the point that they threaten the entire economy at once.

People will kill other people with government. People will kill other people without government. Businesses will do fraudulent things whether there is government or not. No matter what situation, someone will find a way to take advantage of it if they really want to. So yes, someone will find a way to take advantage of fractional reserve banking like they would anything else. Does that mean that there will a "breakdown of the system?" Probably not. Fractional reserve banking in a free market world may put some businesses and banks out of business, but just because one bank or individual in a bank took advantage of fractional reserve banking doesn't mean all banks will go out of business and destroy the world as we know it today in some apocalypse that you see coming from fractional reserve banking.

The only way to hold off the collapse indefinitely and to limit the damage that fractional reserve banking can do is to use the same system the Chinese banks did. Schedule a bank run every week or so. Demand silver - or gold, or Bitcoins - for your deposit slips. Keeps 'em honest.

That was Hong Kong prior to WWII, not the Chinese in general; but yes, that would keep things honest.

Were you not paying attention for the past five years?  Or did you swear off bad news?

Ah. I stand corrected.

You are of course drawing the wrong conclusion, the fact that the flaws exist and are exploitable... ensures that the system will break at some point in time. The problems will either accelerate until they destroy the system or something else will change somewhere else making the entire system pointless. obsolescence is the only thing capable of slowing down acceleration of a flawed system as it nears critical mass.

Or if you don't quite follow that:

"On a long enough time line, the survival rate for everyone drops to zero."

Did anyone on this thread already bring up the point that there may not be a need for banking as we know it with Bitcoin? We mainly use banks to keep out money safe and easily accessible, but Bitcoin allows us to do that on our own (that whole "Be your own bank" thing), so the only reason for people to pool their money together would be to invest in something, be it private loans or large business projects. I.e. banking and investment would be "naturally" separated, the way they used to be until a few years ago. Thus, people's personal savings and checking accounts probably won't get wiped out from bank failures due to fractional reserve and other shenanigans the way they did before FDIC came around, and my hope is that those investing would actually do some research into the investment banks they're putting their money into. Am I wrong about this? (Or overly optimistic about Bitcoin technologies that'll let us store our money on our own devices safely enough?)

Let me put this rather simply...

The entire concept of bitcoin would be undermined by allowing credit creation to happen. If you want to get a loan of some BTC you can sign a contract with someone and get given some REAL bitcoins. That's what a loan is supposed to be. If the creditor is just giving you imaginary credit (like bank credit), then the lender didn't really have anything to lend you in the first place, and they are creating new money out of nothing.

As already mentioned, it's pointless to use bitcoin promissory notes within a fractional reserve system because 1) it's already easy to store and transport BTC and 2) there is no central authority which can guarantee the authenticity of those notes. Of course it is technically possible if some central institution decided to do it, but I highly doubt it would happen because it's too risky for both the institution and note holders.

So in conclusion, bitcoin is not meant to be a currency where the total money supply can be easily expanded by the creation of new imaginary credit. We already have an entire banking system which works like that, and clearly benefits the banks in unfair ways while screwing the rest of us over and undermining the integrity of the economy. We prefer to trade actual bitcoins, not imaginary credit based on a fraction of real bitcoins.

I should have read your post first before replying, because this is actually a reasonable question. As you should be well aware, even with a finite currency, the interest on loans can be paid by debtors who do work and make money from that work. It's a constant circulation of money between hands which allows that to happen. Of course, if we have too many loans at the same time, it could be a problem. But the flaw in your premise here, is that it's unlikely that too many people will issue loans at the same time. And even if they did, the worste case scenario would be that some, but not all of those people, would default on their loans. This exact same "problem" will occur with any finite currency, and that's exactly why they keep printing new government money, to make sure there's enough in circulation to service the ever growing debts. So it's like never-ending a spiral of insanity in my opinion, but by having a finite currency you have naturally built in limits on how much debt can exist.

I don't know how this misconception started, but it seems to be common. Even with fractional reserve banking, if you get a loan, you get real bitcoins, not imaginary bitcoins.

Fractional reserve banking is simple. You deposit BTC1 and the bank loans out BTC0.90 of that BTC1 to someone else. That's it. That's how it works. The implications are much bigger, of course.

I actually did not say there were flaws. I said that if someone really wanted to they can take advantage of other people.  This isn't mutually exclusive to banking. This relates to life and all business transactions in all industries. I have yet to hear someone actually tell me what these "numerous flaws" are.


Oh, you mean the economic collapse caused by a monopoly (central banking)? Did you read the article I posted? That's not a fault of fractional reserve banking, that's a fault of a coercive monopoly.

You seem to be skipping over the most important part of FRB. Those loans are usually redeposited into a bank and used as the basis for a new loan. This process repeats over and over again, until the amount in each account at the bank(s) is much higher than the amount of reserves held. And since the money in those accounts is typically traded as if it were the original reserves (not only as bank transfers but as note withdrawals), the money supply is essentially expanded.

Yes, that's what he meant by "The implications are much bigger, of course."

Truly an enlightening article. Explained in a way even I can understand.

So after explaining fractional reserve banking and why it is not the reason for inflation (the central bank of central banking is), this guy argues for a commodity-backed free banking system (of course as a commodity I myself am thinking: "bitcoin", here).

It has been argued in this thread that with bitcoin banking would be obsolete. I'm not so sure. Deposit/Loan banking is still different from "people pooling money to invest", because with banking, the people (savers) do not usually concern themselves with selecting how the money is invested (who it is loaned out to) nor do they carry the default risk directly.
As I understand it in a free banking system the banks would control each other to not overdue it with the reserves they keep and the riskyness of loans they make. So banks make saving possible in a relatively risk-free and easy way. So they perform a valuable function.

Another thought: Thinking about how supposedly nationstates use their currency to "regulate" their economy (they have a weaker economy so they need to have a weaker currency) and seeing the Euro fail (not sure wether it's because differences in fiscal policy or because all fiat currencies are failing) there is a question bugging me: would a single-currency world economy work?

Much better, once the central planners are tossed to the curb.

You're forgetting the option of a borrower defaulting. Making a loan carries risk for the creditor. He's receiving interest on the loans to make up for that risk. A successful loaning operation will have less cost from loans going into default than interest payments from "good" borrowers and will thus make a profit. Operations loaning out too riskily or at too low interest will see their defaults exceed the interest payments and thus go bankrupt (in a hypothetical system, not in the current fucked up one with the lender of last resort, bailouts, artificially low interest rates and consequent malinvestments, economic inefficiencies, unreliable price signals and of course inflation).

Yup. Much, much better. Of course, Bitcoin's feature set doesn't necessarily lend itself well to physical transactions, and currencies which work well for physical transactions (such as gold) have some significant flaws when you try to make them digital (Ever tried to email an ounce of gold? Doesn't work too well.) so I would suggest a sort of split system: Gold or other precious metals person to person, and Bitcoin or something similar digitally.

I think I know how that misconception works... let me explain by answering to your next part...


Yes. But that's not it, it continues: The BTC 0.90 that bank just loaned out will end up as a deposit in some other bank, which keeps 10% of that (BTC 0.09) and loans out BTC 0.81. This goes on until your 1 bitcoin has become 10 bitcoins. This process is called credit creation and cannot be done by a single bank but only by a banking system.

Now the situation is this: There "really" exists: BTC 1. The sum of the deposits people have at banks is: BTC 10.

From this it is only a small (but invalid) step to derive that a single bank could just create out of thin air € 1,000 in loans as soon as it has € 100 in reserves. An there you have your misconception.

Regarding bitcoin: The above example assumes of course that the borrowers deposit the bitcoin into a bank after getting the loan or that they spend it and the recipient deposits it to a bank. This is a reasonable assumption with fiat money. With bitcoin? Not so much, because in contrast to fiat money bitcoins are easily transferrable by themselves without using the banking system and can be safekept easily by individuals. The only incentive to deposit bitcoins to a bank would be the expectation to receive interest on the deposit (an incentive the current banking system has pretty much been able to abandon due to the other 2 incentives I mentioned above (safekeeping, transferring))

Unless, of course, each person turns right around and deposits their loan in the same bank... But that's splitting hairs.

This is a typical accouting fraud, you can not add the same money at different location multiple times, I don't know how that misconception get published in all the financial educational materials for the universities ;D ;D

Fractional reserve banking is simple. You deposit $1 and the bank can loan out maximum $0.90 of that $1 to someone else. That's it. That's how it works

See this post for details
https://bitcointalk.org/index.php?topic=129423.0

And what happens when that $0.90 gets deposited elsewhere?

At any time, there is only $1 in the whole society. If people save it under their matress, it will disappear from money circulation, but if they put it into a bank (lend it to bank), bank will try to loan it out again and again to increase the available money in circulation

During that process, lot's of money in imagination created, it seems there are $10 in the whole society in the end, but if everyone want's to take it out, they will drive a bank run almost everywhere

In reality only less than 10% of the savings will be withdrawed unexpectedly, so if banks keep 10% they will be fine, but it just shows how much people are addicted to saving

Thank you.

So, then what you guys don't like about FRB is the "virtual" money part. You feel that every dollar on every ledger should be backed by something somewhere. Well, then I'm surprised that you are a fan of bitcoin because there is nothing more "virtual" than a bitcoin.

Anyway, FRB has benefits -- it increases the liquidity and efficiency of the economy. It also has drawbacks -- the leverage makes the system less stable, resulting in booms and busts.

What is the benefit of FRB compared to just printing out more money? At least if you just print it, there is no chance of bank runs.

Let me make this perfectly clear...

The most important property of any currency is scarcity. If it isn't scarce than it can't be a currency, like the grains of sand on a beach, they cannot be used as a currency because it's too easy to acquire them.

Bitcoin is purposely designed to be very difficult to create by requiring a lot of energy to create them, and that gives them scarcity. What we don't like is the fact that banks can lend out money they don't have.

Because in doing so, they effectively create new money from nothing, and it's extremely easy for them to do that. With just a few keystrokes they can create new money and expand the money supply.

Bitcoins are created through real work, so they are in no way "imaginary" in the same sense as bank credit is imaginary. Bank credit is basically like sand on a beach, with the help of the Fed they can create as much bank credit as they want.

However, it's carefully guarded sand. The stockpiles of untapped sand are only accessible to the banks, not to you or me. Want some more sand? Go to the bank, they have unlimited amounts.

This is not exactly true. Even if Satoshi was still the only one mining with his old laptop, roughly the same amount of bitcoin would be created per day. The point is not that bitcoin is hard to create but that its rate of creation is pre-determined. It's only hard because there is a competition (by way of PoW) being held for who gets the created coins. Proof of Stake would probably work equally well and then not much energy would be required.

I'm not opposed to FRB. I even think it might happen... albeit it should (and probably will) be done an open way and the banks can choose and advertise their reserve ratio (aka freebanking).

I don't see there is any big difference in FRB in BTC's form: BTC could also be loaned out again and again and people summarize all the loaned out sum together and 1BTC becomes 10BTC deposit impression etc...

The miners acting as central bank, they generate new BTC, they could loan out them to BTC banks and BTC banks loan out them further. The money supply (coin generation) speed is very stable and halv each 4 year

The biggest difference comparing with USD, is that FED change the money supply speed in order to reach price stablility, e.g. the USD should keep its value relatively stable. But BTC money supply speed could not be changed, so the price of BTC changes very fast, and that bring much more difficulty for a loan: You never know how much you gonna pay back when you borrow from a BTC bank

No one, not even the miners, can generate new bitcoins beyond the limits of the protocol.  FRB is not possible using actual bitcoins.

please check the other post about common misconception about FRB or so called money multiplyer
https://bitcointalk.org/index.php?topic=129423.0 (https://bitcointalk.org/index.php?topic=129423.0)

FRB is: You save (loan) 10 BTC to a bank, since this is a fixed saving, you seldom have the motivation to withdraw before the period ends, so the bank loan out 9 BTC during that period to other people before your saving mature

If FRB = Fractional Reserve Banking then you're wrong, it's perfectly possible to do it with bitcoins, as it was possible to do it with gold.
The only thing that the protocol limits is the monetary base. Higher aggregates can exist.

That said, the concept of a "central issuer" inflating the monetary base to save the banks that took too much risk cannot exist with bitcoins directly, as with gold.

Right on the spot.

The problem with a BTC loan is its unstable (and more likely continuously rising) price

If I borrow 10 BTC from a BTC bank one year ago, it would only cost me $20, but if the loan is 1 year, now I have to pay back $130, that is a 550% interest, no one will take this kind of loan. From this point of view, the OP's claim regarding BTC does not allow credit creation is actually correct

In a rich society with excessive production power, no investment is very attractive and people will try to find a way to protect their savings due to central banks are continuously inflating the main currency to stimulate investment, then BTC is a promising vehicle

Just as with gold, it would be done with deposit slips, not actual Bitcoins. You can't loan out more coins than you have, the protocol won't let you. FRB with BTC would require issuing a BTC-backed currency.

We are talking about two different things, I think.  FRB with gold was different than modern FRB.  With gold, the bank would usually be lending by offering a promisary note or a warehouse receipt based upon gold that was kept in the bank.  It was really just faith in that bank that they could actually perform should the deal go sour, not really that there was that much gold available.  While it's possible for a bitcoin bank to do something similar, the network (which the bitcoin economy is dependent upon) will not accept promises or warehouse receipts, only actual bitcoins.  If a bitcoin bank were to sell CD based upon the idea that those bitcoins would be lent back out, yes FRB would work, but that would be more like the free banking era after the Civil War, not the modern version of FRB.  Yet, such a bank would have to be open and honest about such a thing, and keep whatever on-demand accounts that it maintained completely seperate from those lending funds, or a run would eventually destroy them.  Such things happened on a regular basis during the free banking era, as bank owners got to greedy and too confident that customers wouldn't ever lose faith.  If a bank were to offer bitcoin bonds, and then lend those funds out in loans, the honesty of the pattern might just permit things to work.  Practically, however, modern banks don't work this way.  A modern verison of a bank actually gets it's 10% reserve requirement from savings accounts of all kinds, and then lends out funds that have never existed to 9 times that original deposit amount.  It's the implicit backing of the central banking (and thus taxpayers) that permit such an activity.

FRB (Fractional Reserve Banking) doesn't require the lending out of more coins than you have.  It requires the lending out of someone else's coins.  You don't need a BTC-backed currency. It can be done with BTC.

Example:

You and 100 other people all deposit 10 BTC each at my bank,  I loan out 10 BTC of what you all have deposited to someone who needs it, and they will be paying me back 1 BTC per month for the next 11 months.  Any one (or more) of you can withdraw any or all of your BTC as long as at least some of you leave enough on deposit for the total deposits to be equal to unpaid principal of the loan at any time.

It isn't honesty and/or keeping on-demand accounts separate that prevents the runs on the bank.  It is the introduction of a deposit insurance that the depositors have faith in.

If a trusted insurance company were to offer to insure the banks deposits, then the on-demand accounts balances would not need to be separate, and the bank would not need to tell the public what percentage of the deposits were being held in reserve.  It would be the insurance company's responsibility to regularly audit the bank and make sure that there were sufficient fund in reserve to maintain an acceptable risk level for the insurance company.

I stand corrected. I doubt you could get away with a low reserve percentage for long, however.

You don't really need deposit slips or bank notes (promissory notes, IOUs) as long as you can convince people to keep their bitcoins in their "bank account". You will most likely also want to convince them to use your "bank wire transaction" feature to transfer bitcoins to other peoples bank accounts within your banking system.

^^ Which may be difficult when Bitcoin already allows you to transfer address to address yourself, and services like blockchain.info have shown that it's possible to provide the convenience of online banking without the bank having any access to your coins.
Exchanges are still a problem in their current "pool all btc together" form, and MtGox could easily be reporting a higher BTC balance than they actually have, and no one would be able to verify that.

There are a variety of reasons people may choose to use banks instead of just keeping their own secure wallets. Perhaps they trust the bank to do a better job of securing the bitcoins than they believe they can do themselves?  Perhaps the banks offer to pay a small interest rate on deposits? Perhaps the banks provide a convenience for engaging in bitcoin based transactions in the physical world (debit cards, checks, etc)?  Perhaps the banks offer reduced transaction fees?

Blockchaininfo.com provides the security, but leaves one last component that decrypts your private key to you. It's like they store your money in a highly secure bank vault, but still need your key to open your suitcase of money inside.


Maybe with Bitcoin slowly growing in value anyway, there won't be a demand for it. And if their is, hopefully the banks will separate banking (storing your money safely) from investing (letting you put some of your money into accounts used for loans and other investments). But you're probably right, we'll likely have interest bearing accounts, with subsequent bank failures from managers who got too greedy, and people learning lessons over and over about not investing everything they have in one place.


Bitcoincard, and phone wallets will hopefully solve that problem. Or any new technology we haven't seen yet. It's already possible to store all your coins directly on your device, or sign and send transactions for coins that exist on blockchain, without the online bank having access to them.


That is only possible within the bank, by bypassing the Bitcoin network (the way MtGox gives you a BTC address, but actually stores everyone's coins in a single pool). I guess that could be a bonus if you're only doing business with others who also bank at the same place

And what happens if you lose your keys?  A bank can drill open the bank vault, but I don't think anyone will be drilling open your private keys.


Right up until you drop your phone in the toilet, or it gets stolen, and then you lose all access to any addresses that had the private key on that device.

It is also possible if multiple banks (in the interest of reducing their own transaction fees) agree to settle up interbank transactions at the end of the day (or week, or month, etc) with a single transaction.

Example:

Customers of bank A send 1,000,000 worth of bitcoins spread out through thousands of transactions to various customers of bank B.  Customers of bank B send 1,000,010 worth of bitcoins spread out through thousands of transactions to various customers of bank A.

Bank A and bank B have a system in place for validation and balance updates between them. At the end of the chosen timeframe when it is time for the banks to "settle up", bank B sends a single 10 BTC transaction across the blockchain to bank A.  They pass on the transaction fee savings to their customers (keeping a bit for themselves of course).

The value of my (and everyone else who did not lose them) Bitcoins goes up. The world thanks you. Same as if you forget to back up your wallet.

The bank will store your keys. That's where their part of the security comes in. You just have to make sure you remember your password to decrypt that key, which you can also write on a piece of paper to store at home. Frankly, same for your keys: blockchain.info let's you print your private keys to store at home, or back them up to a number of online storages. So, you get the convenience of banking anywhere online, they provide the security, and you provide backups if you want.


Same as above. My phone wallet's private key is safely backed up at home. If I lose the phone or it gets stolen, the phone is locked, and I just move the money elsewhere.


That may happen, and depending on the size of future transaction fees may be inevitable, but then people would have to chose, pay a transaction fee, or give someone else full control of your money. We're used to giving others full control of our money because normal money can't work any other way. With the possibilities that Bitcoin allows, and a few more scams and bank failures, not giving the bank control may become the norm.

BTC bank's income will mostly come from tranaction fee, loan (the bank's main business today) is basically not working with BTC.

No credit creation is happening since the money supply increase is always slower than the expanding of the economy

Seems to be working OK with IBB. Granted, I'm not making 7000% on my investment, but it's a slow and steady profit.

True! I almost forgot that I can always check the blockchain for my account balance, so that banks won't be able to move that fund

The blockchain based banking do not allow FRB

Certainly bitcoin banking would allow FRB.  You can check the balance of bitcoin that the bank is holding in reserves only if the bank chooses to provide you with the list of bitcoin addresses where all their bitcoin is stored and provide you with proof that they have the private keys associated with those addresses.  But even then, you only have half the story.  You know how much they have in reserve in total, but you have no knowledge about what the total is of all deposits they have.  A bank won't keep your funds segregated in its own address anymore than they keep your fiat segregated in its own envelope.  All deposits get mixed together.  The bitcoins you withdraw aren't likely to be the same ones you depoisted.

I think you lost track of your analogy here.

The "password" is the "key" that allows you to access your money in the "vault".  With a bank, you have a banking password.  If you forget/lose it you can contact the bank and once you prove your identity they can re-issue you a new password that allows you to access all the money that they have been keeping safe for you.  With a service like blockchain.info wallet, if you forget/lose your password you can pretty much forget about ever getting any access to that money ever again.


Yours is.  But many people are not as good about maintaining a regular schedule of creating recoverable backups.  These are the people who will be interested in using a bitcoin bank for the "safety and security" provided.  Furthermore, if their private key is backed up on a computer that is accessible from the internet, then they have to worry about hackers, viruses, trojans, etc.  Again the people who aren't capable or willing to protect themselves from such attacks are the very people who will be interested in the safety/security that a bank will provide.

Reliable banking won't be available until someone finds an insurance company willing to insure the deposits.  Once that happens, bank failures will be far less of a concern.  As for scams, that is just another service that banks might offer.  They could alert the bank customer if an attempted transaction triggers some sort of "scam filter" that they create.  If we get to the point where bank to bank transactions skip the blockchain, then the banks will even be able to begin to offer "chargeback" services to their customers to protect them from scams.

Exactly. Which is why some people will opt for the security of a bank to protect their ability to access their funds.

Then it is not a blockchain based banking, they have created their own accounting system to track transactions

Historically the reason for banks doing this is because the interest difference between loan and deposit could generate income for them, so the more they can loan out, the more income they will get

But with BTC, loan is not very common (people would rather take loan in an inflating currency, USD for example), this scenario is less likely to realize

You should look over in the "lending" part of the forum, there are people making loans in btc right now.

This depends on the definition we use for the phrase "blockchain based banking".  When users withdraw bitcoins to their personal wallet, it will still pass through the blockchain.  When banks send to other banks that they don't have a processing agreement with it will still pass through the bockchain. But yes, to have Fractional Reserve Banking, the banks will handle many of the bitcoin valued transactions outside the blockchain.

someone there claim that 90-95% of people there turned out to be a scammer

And even without scam, loan in BTC will have problem

yochdog's 10000 BTC loan at 10% annual rate is a good example

At the end of his post, he claimed that he want to pre-pay the loan since the rising exchange rate already made his day much much harder

Of course, he could get those BTC to buy new ASIC mining rigs, which in turn can generate some coin to pay back his loan, but anyway, when you want to borrow money, you always borrow the money with the lowest interest rate (inflated money), like those carry traders do

I bought a small quantity of bitcoins a couple of months ago. In that time, no one has decreased the value of what I hold by counterfeiting more bitcoins. In fact, my holdings will currently purchase approximately 33% more USD than when I purchased them. What's not to like?

This assumption is simply wrong.
There is no line of code supporting such a conclusion.

Any currency is not allowing credit creation out of its own.
It's how the banks (ab)use money that allows credit creation.
Apply this to Bitcoins ... and there you are.