Bitcoin Forum

Just reading through this article.

Bitcoin: Questions, Answers, and Analysis of Legal Issues
www.fas.org/sgp/crs/misc/R43339.pdf‎

On Page 6
Under heading:  "No Erosion of Purchasing Power by Inflation"
Paragraph 3, Sentence 2:

"Inflation could also occur if the Bitcoin network develops fractional reserve banking (i.e., banks that hold only a fraction of their deposits in reserve and lend out the rest), which would also be a vehicle that effectively increases the supply of circulating Bticoins.


The upper cap on the number of Bitcoins at a known, unchangeable number of 22million, along with a predictable increase in Bitcoins until that number is reached, is absolutely one of its key features for benefiting the masses.  This is because excessive inflation / reduction in buying power through fiat money printing by private central banks is tantamount to theft from the masses.  The Bitcoin network avoids this.


Just wondering, from a technical side, how a fractional reserve banking-based alteration to Bitcoin would be achieved and how we can stop it / protect the bitcoin network from this.

It would be achieved by getting people to accept promissory notes instead of actual Bitcoins. You probably can't stop it and it doesn't require a network change.

Is there no way of telling that a particular coin has its source in mining rather than a promissory note?

Eventually some people will accept bitcoin paper.  Once enough people accept Bitcoin paper then they are off to the races again (fractional reserve of actual Bitcoin to create Bitcoin paper, inflation of the paper - not the actual thing, etc.)

However, you personally can always refuse the notes and only accept and hold the real thing.

Your question makes no sense.  A Bitcoin is a Bitcoin, a promise to pay you a bitcoin is just a promise.

Very simple take delivery of your BTC, sit back and enjoy the fireworks.

Fractional reserve banking by its very nature involves a short play, namely a promise to pay something one does not have, on the expectation that the lender or "depositor" will not ask for it back or "take delivery". There is no more effective way to squeeze the bears to the wall in any market than to take delivery.

By the way the BTC market saw a sizeable example of fractional reserve banking with pirateat40 and his "trusts" in late 2011 and 2012. I strongly believe that he single handedly depressed the BTC/USD market during 2012 and when it all blew up the price sky-rocketed in 2013. Those of us who were actively buying BTC in 2012 and taking delivery profited handsomely from the pirate affair.

Actual bitcoins only exist on the block chain. If your bitcoin is on the block chain, it's a bitcoin.

If you accept a note claiming to be a bitcoin, yet you can not manipulate this coin on the block chain, you have a promissory note.

Fractional reserve banking will be easier to keep in check with Bitcoin as we can always see actual bitcoins on the block chain. If a Bitcoin bank wishes to engage in FRB, it's users can demand the bank submit to audits by proving it controls a certain amount of bitcoins on the block chain. The beauty of the block chain is that it is a public ledger which can not be faked.

Now banks can compete for their customer's business by offering good interest rates on deposited bitcoins which they will loan out, yet the customers have methods to keep the banks honest.

Also, promissory notes will probably not be fungible with actual bitcoins (because it's so simple to tell them apart), the real thing will command a premium.

Many suspect Mt Gox of engaging in fractional reserve banking hence the fiat withdrawal problems.  

Good luck auditing any exchange they won't cooperate.

By definition any fiat or bitcoin held on an exchange is an IOU.  The comment above is correct in that the market is factoring in a 15% risk premium for Gox USD.   If it is true that Yen withdrawals on Gox are also broken then the 15% premium is too low IMHO.   

Bitcoin opens to the door to transparent FRB. One can enter into a contract with their bank stating that they will deposit and not take delivery of their bitcoins for a certain period of time. The banks will have to offer competitive interest rates in order to get people to enter into these contracts. Of course, unlike pirate@40, the customers would be wise to demand third party auditing of the books. ;)

The more relevant question is: Is a particular BTC promissory backed by actual BTC, and if so to what extent.

By the way there may be a situation developing with gold. Just search for "GATA German gold". If the conspiracy theorists are proven correct and this blows up it will have a profound impact not only on the gold market but also on the BTC market.

Indeed. One risks losing their deposits by trusting organizations which do not submit to an audit.

It worked for gold and other assets for a few hundred years.

In fact, it's inevitable.  You have a situation where people are sitting on large wealth in an asset that doesn't do anything productive.  Sell it and you risk missing long term appreciation.  By loaning it, others can put it to productive use.  

The difference with Bitcoin is that there is a widely distributed public ledger which allows for transparency unlike anything we've had before.

I don't follow gold but know it is claimed the US does not have the German's gold. What would be the impact on the gold market if this is true?  I don't see a direct impact in fiat which is not backed by anything.

This seems like a bit of an opportunity for any new crypto; or for Bitcoin, if it can manage the change...a Fractional Banking-resistant Coin.

Some type of embedded auditing or some type of way to ensure that balances held across exchanges is frequently confirmed against the blockchain...is that even possible?

I do think it is desirable, since, out of control, fractional reserve banking is a bad deal for the masses, and always the biggest benefit to the 'already-rich.'

Regarding fractional reserve lending of bitcoin it is a very dangerous game.  If the price jumps by 1000% your debts (measured in fiat) also jump 1000%.  

This can make you insolvent very fast.  My guess is that Gox has been fractional reserve banking bitcoin since day 1 and has been caught on the wrong side of a 10,000% price increase which means they could be $US billions of dollars in the hole.  They can keep going until someone sues them in Japan for not coughing up their fiat (which will happen if not now then on the next price jump).

Ironically this makes new exchanges safer than old ones because they have not had the opportunity to get caught with their pants down for such a huge price swing.  

The answer is systems where the depositor continues to control the private key or part of a multi sig. 

That would be good.  I am wondering what the lowest level in the protocol / implementation would be that something like this could be achieved.  The lower the level, the less trust required=better IMO.

Yes and probably what concerns the powers-that-be the most.

Pretty sure multi sig is in the core protocol just not implemented yet.  But develpers will be extremely cautious so don't expect it anytime soon.

FRB is not possible with bitcoin, since people will always prefer to borrow inflative money

And FRB does not create more money , just created an illusion of more money , only QE can create more money

   This is an informative post and answers a few things I've been wondering about - so thanks.

 I suppose, then, the unknown becomes the extent of consumers demand for credit and/or interest and how much risk they are prepared to take on for that credit/interest. What would be deemed to be an acceptable "defict" in the level of a banks reserves ?

   I guess another factor is that the banking market could be wide open with BTC - globally. What would be to stop me from borrowing/depositing BTC with an overseas bank that I recognised to have a more solid balance sheet ?
    

I thought that FRB does create more money.  Money is lent into existence. 

If the reserve requirement is 10% and a bank has a billion, a bank can create, in the form of loans, 9 billion.  That is considered to be 'real' money that is introduced into the overall money supply.

That was my understanding anyway.

Wouldn't the bank have to borrow the 9 billion from elsewhere - thus its already in existence ?

You lend out the same $100 note 10 times, the accumulated lending is $1000, but you do not have more than $100 at any moment

FRB works like GUI, to confusing people with illusions

My understanding is that with FRB, money is created out of thin air (or essentially so) through debt-based money that is introduced into the system, thereby in effect stealing buying power / work effort from everyone who works and saves...i.e., the masses.  That's why FRB is so parasitic in my view. 

I really like:
"Money as Debt" by Paul Grignon for the best overview.
http://www.youtube.com/watch?v=jqvKjsIxT_8

Also, if you've got an extra 3.5 and 2 hours.
"The Money Masters" by Bill Still (yes the same guy who supported Quark but he is still quite awesome on the topic of fair money)
http://www.youtube.com/watch?v=iDtBSiI13fE

"The Secret of Oz" by Bill Still
http://www.youtube.com/watch?v=swkq2E8mswI

Also, if you're feeling particularly ambitious, this is an awesome book on debt money and its global implications.
"The Grip of Death: A Study of Modern Money, Debt Slavery, and Destructive Economics"
by Michael Rowbotham
http://www.amazon.com/The-Grip-Death-Destructive-Economics/dp/1897766408/ref=sr_1_1?ie=UTF8&qid=1390431034&sr=8-1&keywords=the+grip+of+death

And also, a great website on fair money.
www.positivemoney.org

Merging the ideas for fair money with the technology that underlies Bitcoin is both fascinating and important.  Hopefully we can make it happen.

I don't believe we can have fractional banking with BTC as BTC was created to live in a reality opposing this kind of monetary system with a deflationary value. It goes against what Bitcoin stands for and I believe it is totally unnecessary. Yes Banks can own Bitcoin and Wall St has already jumped in but as long as Bitcoin is being mined I can't see this as a danger.

Sounds good to me.  I'm also fully against any kind of FRB within the Bitcoin context.

If the reserve is 10% and the bank has a billion, it can loan 900 million. This means on 1 billion dollars there are 1.9 billion in claims on those dollars. The loaned 900 million could then be deposited at another bank, and 90% of it could be loaned, resulting in another 810 million in loans, resulting in 2.71 billion in claims on the original 1 billion, and so on. This works fine until there is an economic problem that causes an unusual number of bankruptcies or reduction in investments and such.

The money is generally not created arbitrarily, the banks are supposed to weigh the risks and they earn their profit based on successfully gauging those risks. It has been proven multiple times in the last few hundred years that banks cannot be trusted with this responsibility.

This is how we combat undisclosed fractional reserves, and other dishonest financial games: http://bitcoinism.blogspot.com/2013/12/voting-pools-how-to-stop-plague-of.html

If the required reserve ratio is say 9:1 (so around 10%) and the bank has say $1111.12 on deposit, the total amount of new money that can be created is around $9000 initially and then all the way up to $100,000 if the full sequence is followed to its conclusion (i.e., assuming the initial $9000.00 are redeposited by the borrowers and so on and so on).

This is at least the 3-step explanation starting at 13:00 of "Money as Debt"
http://www.youtube.com/watch?v=jqvKjsIxT_8

This is not correct. If the reserve is 10% and the base money supply is $1,000, the absolute maximum currency in circulation can be $9,000. $1,000 must be on hand at the federal reserve to maintain the reserve ratio. A bank cannot loan out $10k on a $1k deposit, they can loan out $900. If Money as Debt says otherwise, it is misinformed.

This is a wonderful site that thoroughly explains the mechanics of the US monetary system: http://wfhummel.cnchost.com/index.html

You've seen paper wallets and stuff right? The reason these work and still retain their value is because they have the private key stored on the block chain, if somebody tried this everybody would be able to tell because they'd get some of the notes, check the blockchain and then notice that the private keys etc. are fake.

Counterfeit Bitcoins are an extremely unlikely scenario right now, we've already had exchanges try to fake their trade volume and it was spotted very quickly.

So are we talking about the same thing?  Because the same rationale/example for what is described in Money as Debt is found here, except using a 20% reserve requirement.
http://economics.about.com/cs/money/a/reserve_ratio.htm

Is it possible that these 42coins were counterfeit ?

That link explains the same thing I did ($20 billion at 20% means $100 billion maximum possible supply, $80 of which is in circulation, $20 is reserved). Money as Debt does have it wrong. If you have $1,111.12 in reserve (aka base money), your maximum liability is $1,111.12/.1 or 11,111.2 meaning you can have a maximum of $10k out on loan, it does not mean you can create $10k--it would either have to borrow the 10k or have more deposits. If a bank wants to make a loan for $100k with a 20% reserve, it must deposit $20k with the federal reserve before it can make that loan. Technically, anyway, though in practice it is not that simple.

The difference may sound subtle but it is significant and it is confused frequently. An easy way to see that it does not work the way Money as Debt describes is that if there were a 0% reserve, an infinite amount of credit money could be produced at will, but this is not the case--checking accounts, for example, have no reserve in the US already.

FRB only works because "credit money", created from loans (currency as debt), is fully fungible with deposit currency and government printed fiat currency.

FRB under a gold standard requires that banks which lend irresponsibly (over 100% of capital) should face bankruptcy if too many loans go bad. This did create a lot of booms and busts in the 19th Century, although living standards continually improved and commerce thrived. Central banking is the reason the gold standard broke down, because central banks backstop retail and merchant banks with printed money which rapidly outpaces the amount of central gold holdings. Central banks create greater systemic risk, but also persist because they fund spendthift politicians in government which inevitably fall victim to the siren song of buying votes with taxpayers money in order to win re-election.

Bitcoin makes FRB obsolete because credit money is no longer fungible with bitcoin savings. A bitcoin bank which lends out bitcoins can't pretend to still own them as assets. It will have bitcoin-denominated loans, but these will be clearly promissory amounts not reflected in the blockchain. Loans may exist in a separate blockchain, or as smart property amounts, but they cannot be confused as bitcoins.

Bitcoin also makes central banking obsolete as bitcoin banks cannot be backstopped with printed money.

If the banksters wanted to play our game they might try to come up with a digital "promissory coin" that they alone can issue with no upper limit. They could honor it on a 1:1 basis against Bitcoin without having mined or held a single BTC making it a 0% fractional reserve.

Ok.  Paul Grignon offers a good clarification on this and a related point.
http://paulgrignon.netfirms.com/MoneyasDebt/disputed_information.html

The main thing to focus on is that, in practice, the present system continues to rapidly drive up money supply / inflation and with it debt, in effect stealing from the masses in two ways:  1) by decreasing buying power of any money we may have saved; and 2) by charging interest on money that was created out of thin air.  That's parasitic.

Hopefully a system like Bitcoin, which has much more transparent accounting of the money system built in, can finally do away with this bogus, rent-seeking system.

That's what the money mongers are afraid of...with Bitcoin it's much more difficult to manipulate our trust...it's all about the blockchain.

The gravestone of the banks will read:
"RIP Banks:  Too much was not enough"

I know this is not a technical thread but I must correct some of your statements in case someone reads them and thinks them true:

No.  The private key (should) never leave your wallet.  The private key never appears in the blockchain.  The two things that do appear in the blockchain are the public key and the hash of the public key which we call the Bitcoin address.

I assume what you are talking about is the following scenario:  someone gives you a paper wallet and you accept it for payment.  Now correcting you once again a paper wallet has the Bitcoin address displayed and the private key is hidden under a sticker.  You can check the Bitcoin address on the block chain but all that proves is that address has the BTC.  It does not prove that you have the private key under the sticker that you need to actually claim the BTC into your wallet.  The only way to know for sure if a paper wallet/note is legit is to destroy it, open up the sticker, take out the private key and import it into your wallet.  If you are smart you also move the BTC to another Bitcoin address just in case the note has been duplicated.

It is very easy to create conterfeit paper wallets.  All I have to do is produce 100 paper wallets with the same Bitcoin address on the front and then "forget" to put the private key under the sticker.