Bitcoin Forum

How I used to think about lending at interest:

Taking a systemic view (nodes of a graph containing money with edges representing debt), lending at interest must over time concentrate the currency in the hands of a few (essentially one node in the end). I deducted: The rich will get richer, the poor will get poorer and concluded: lending at interest is evil.

I deemed this view of mine validated by observing the rich actually becoming richer and the poor becoming ever poorer.

What I overlooked:

There's risk involved in lending, namely the risk of the borrower defaulting. Therefore above does not necessarily hold true, but why does it still seem to be true?

Why is it still true (that the rich get richer)?

Well, for other reasons: Mainly because these "rich" are able to lend out money they don't even have in the first place, and maybe more importantly because they are being bailed out every time a borrower has problems.

Also because at least some of them are in the business of just simply ripping people off and are able to get away with it somehow.

What I think now:

Fractional reserve lending with a lender of last resort that will bail lenders out at the expense of all other parties using the currency in question is evil.

And: stealing peoples money/assets is evil.

What I'm getting at:

Since fractional reserve lending is not possible with bitcoin and there is certainly no lender of last resort who can just print up more money, bitcoin-based lending/borrowing is not evil.

The lender is exposed to the risk: in case of default he is parted of his money, he can't be a cry-baby but has to take it like a man and just suck it up.

In a "good money"-based economy, the market will adjust the price of money (interest rate) such that lending is barely profitable and will reflect market participants needs.

any comments/corrections?

EDIT: added some strikethrough after realizing frb was possible with bitcoin.

+1

Although not evil to lend BTC, people will not borrow BTC if they expect the value of BTC will rise, they tends to borrow the thing that is dropping in value

well, people borrow BTC for whatever reason, I don't know. See this thread for example https://bitcointalk.org/index.php?topic=66802.0

I just have a couple of small comments, molecular.

FRB with Bitcoin is technically possible, and there are examples where it occurred in the past (albeit unintentionally or as a result of fraud, and was very short lived). Merely, I argue, the empirical features of Bitcoin (form-invariance) make it less likely for FRB to be widespread and/or have an effect on the money supply.

Many Austrians argue that without credit expansion, the business of banking (intermediary between lenders and borrowers) would have the same profitability as any other business, which on average means the market rate of interest. Even if you hold the opinion that FRB does not necessarily violate property rights, bankers are still benefiting from a legal privilege. Normal people cannot perform credit expansion: the regulators would fine you (or worse). Even during the "freebanking era" in the USA in the 19th century, banks were regulated.

People won't lend USD if they expect the value of USD will shrink?  It's all about price.

People will lend the decreasing currency as there payments on the loan will be of less and less value, while the things they may have bought with the loan might increase.

Above: They WOULD borrow dollars and they would NOT borrow BTC.


Op is correct in his observations BTC solves a slew of problems with the banking industry.

Another interesting thing is that giving a loan and buying a stock are very similar - risking your money for potential gain roughly equal to the risk.

Insuring loans against default is hence logically impossible: The fee the insurance company would HAVE to take to stay in business would be everything you could charge in interest by market rates.


If I was a gambling man I would loan a million fiat and put it all in BTC, my BTC would raise much faster than my loan would mature and I could then pay it off and come out with a profit - or go to jail!

It's good you've changed your mind; to cement the idea I recommend a browse of Bastiat's Essays on Political Economy.

The important point he makes is that the borrower benefits from the loan; which is what pays the interest.  Lending of capital to someone without it benefits both parties; just like all free market mutually agreed trades.

You're correct, I didn't think of that, "wealth creation".

So you're talking maybe about something like a new market participant entering the market (kid gets his first wallet, filled with some money by dad). This in itself doesn't make much of a difference, though, since the new node that just popped up is receiving money from existing nodes spending. It would only change something if the new node received money from the "rich lenders" (possible: the kid can sell some service or maybe sell his newly hyped-up dotcom to "rich lender", for example). So it boils back down to "rich lender" spending enough (more than his interest profit) or not (doesn't make a difference wether he spends to newly created or to old nodes). In other words: no matter how many new nodes are created, if the money doesn't come from the group of "rich lenders", my reasoning is still valid, right?

After all, "wealth" (or better "monetary wealth" or "richness") isn't just created out of thin air, it's always transferred from somewhere else (even in the case of money supply increase by printing)


You're saying the risk grows larger over time because the remaining amount of available currency for the borrower to tap in order to pay back is decreasing over time and therefore the probability of a default increases? Interesting... can't find anything wrong with the reasoning. Actually, with a finite amount of money and interest having to be payed to - say - a single lender, who everyone borrowed all their money from, it's evident that the probability of default must reach 100% at some point. ("I want the earth plus 5 percent": http://www.relfe.com/plus_5_.html)

With respect to the risk of default, I agree that lending for free is inappropriate. However, I don't understand why the price for lending should grow over time as it does in an interest-based model. Wouldn't a fixed fee for lending be more appropriate?

But even if real wealth creation grows, that doesn't mean the size of the currency pool grows. Since most debts are denominated in currency rather than something like multiples of the CPI, the systemic concentration theory still holds.

I agree that the correct interpretation for how to resolve it is to point to the fact that eventually there has to be a collapse. And that's why I point to what I think is the highest evil in the modern monetary system: unnatural collapse prevention financed on everyone else's backs.

Why must it be the rich that lend to the poor? Rich people borrow funds all the time for their ventures, which ultimately come from the public.

Also, even if the rich do lend to the poor, the net effect needn't be that money flows from the poor to the rich. Rich person lends to poor(er) person; poor person starts a business; business makes product; rich person buys product, moving funds from the rich to the poor, possibly more than the interest paid.

Why would it be evil? For whatever reason, the borrower values X now more than X+e later. He willingly enters an agreement where he gets X now and gives X+e later. Both the borrower and the lender benefit from this. When borrowing for a business, presumably the borrower makes a net positive monetary gain from the loan.

It is only evil if the lender works to create harmful conditions for the borrower which cause him to need the loan, or deceive him into thinking he needs the loan. The same as any other business.

Logic fail, assuming you mean by "validated" anything more than very weak evidence.

What do you mean by this? All the big lenders in this forum are fractional reserve, they take deposits, keep a small fraction in reserve, and lend out the rest to create a return on investment.

Fractional reserve banking, where people deposit funds for reasons other than receiving interest, and the bank does not keep it in full reserve, is obviously also possible with Bitcoin. It's just less likely to be common, because with Bitcoin there's not much need for a bank anyway.

I like where you are going with it OP.

The ying to interest's yang is the risk of loss from default, inflation, etc.

Without that risk interest rates should approach US treasury rates (technically not 0 risk but prices as very close to 0 risk).  Ranging from ~0% on credit cards to ~2% on mortgages.  Banks which suffer no risk of default (though ability to regain solvency through borrowing at the FED discount window, taxpayer subsidized bailouts, etc) but charging rates at higher than 0-risk are immoral and unethical. 

Lending is like any other product or service, and the interest is the payment for it. It's not unethical to charge what the market will pay.

/thread

Of course it is when you steal from the taxpayers.

The banks are certainly free to charge what they want and when they made bad bets they should have gone out of business.  If that had happened this thread wouldn't exist.  Did you even read the OP.

To charge interest to consumers and then to take bailout money from the same consumers is unethical. 

If their bets win, they win.  If their bets lose, they still win.  In the former wealth flows to the top via interest, in the wallet wealth flows to the top via govt bailouts (which is a nice way of saying $10T in free cash paid for by every single taxpayer for decades).  

You can't do that, I can't do that.  

Only banks with the monopoly on the issuance of legal tender can pull off that heist.  They are exploiting their monopoly given to them by the people for the public good to confiscate wealth that was neither theirs nor earned.  To call it ethical is insane.

Hardly.  That pretends the banks are operating a fair game. 

It would be like saying a casino which accepts wagers and keeps the losing bets but fails to payout winning bets it ethical.  Worse in this case the casino is required and only members of the banking cartel can operate one and even if you minimize your involvement in the casino, the actions of the casino continually devalue your chips through no fault of your own and those chips are the only form of legal tender in the country.

Saying /thread is just stupid. 

I'd say it's a problem with the other aspects of the system, rather than the lending itself.

Anyway, the main thing I took issue with is the implication that the US treasury rates are somehow the "true" interest rates. Even without risk there are many things that go into pricing. e.g., the banks borrow funds at some rate, but they also need to pay for marketing, clerks etc., so they will need to lend out at a higher rate to make a profit - even if there is no default risk.

Right. The banks are bad. Fuck the banks.
Can we go back to talking about lending at interest now? Pretty please with a cherry on top?

Still talking about banks? Shit, man, you really have a penchant for banks.

https://i.imgur.com/r8EJz.jpg

The OP was about banks.  Maybe you should read it?

It relates to banks, because it talks about fractional reserve lending, but its primary focus is not banks.

Bailouts or regulatory problems have little to do with lending itself.

I was searching for how late in the post the word "bank" is first mentioned, and realized it doesn't appear in it at all. The post is about lending.

Meni, thanks for your answer, got some comments...


It doesn't have to be the rich that do the lending, but in the naive view I held back then (forgetting the lender was also spending), the lenders would perpetually grow richer and if they had been poor to begin with, they would become rich over time. With lending continuing the money would keep flowing towards the "already richer" nodes, because they can/will do more lending and therefore receive more interest, until in the end, all currency is concentrated at a single node. This might also answer your later question why I considered lending at interest to be evil: all money in the hands of one (even as a tendency) just had to be unethical in some way.


Yes, I ignored any other money flows in my naive view, which I retired.


I stand corrected. After reading the wiki article on frb and bitcoin (https://en.bitcoin.it/wiki/Fractional_Reserve_Banking_and_Bitcoin) I agree with you. Thanks for the kick. I will correct my original post to read "Since with bitcoin there is certainly no lender of last resort who can just print up more money, bitcoin-based lending/borrowing is not evil." and agree with Vitalik:

The existance of bailouts makes lending at interest unethical for the lenders potentially profiting from these bailouts (socialize the risks).

Cool, I know this was a view you no longer hold, but it just seemed that maybe you still hadn't shaken all of the flaws with it.

He didn't literally say "bank" but I don't know of any other rich entity that gets bailed out in the way described.

Don't get me wrong, I understand what you're saying; it is POSSIBLE to ethically lend fiat at low or no interest without accepting bailouts. But in a market where some participants get bailed out, those who don't accept bailouts will be unable to compete. You would either
* Charge customers enough to stay afloat and your rates are higher than big banks - everyone borrows from them instead
* Charge customers the same rates as big banks - your investors pull out in favor of safer options like the big banks

I think you're fixating on him, fixating on banks. He's on topic, OP's realization is the flawed system of "risks" that can be written off at the cost of everyone.

I personally would only call it fractional reserve banking if it involved maturity mismatching. If the deposits are not payable on demand, for example, that would be an indication it might not be FRB, but loan banking.

Based on what I read, what happened historically was that bringing together lenders and borrowers (loan banking) and keeping deposits were two different services, done by different businesses. Once the deposit keepers noticed that people use the deposit certificates as a medium of exchange, they expanded their business. They started to overissue. This allowed them to also act as lenders, and thus FRB was born.

Generally the deposits are payable on demand, up to a few days.

This is where it gets a bit fuzzy. In the monetary system we live in, I lean slightly towards not classifying "a few days" as on demand, but it's unclear. I suppose this could technically be called fractional reserve banking, even though without the deposits being accepted as a medium of exchange, it would not be "FRB as we know it".

Fiat money lending is not a business because it involves money creation. Today its under regulatory capture by a cartel of banks organized around a monopolistic monetary system.

The "default" risk supposedly borne by the bankers is a joke when in fact they create money out of thin air by issuing credit. How can you lose something you don't own in the first place ? Bankers charge insurance premium on top of their interest rates so the borrowers pay twice (that's how it works for mortgages in Europe for instance).

Time value of money ? Another joke if bankers can create money out of thin air unless thin air is more valuable today than tomorrow (I know most bankers will argue for that with a straight face).

Bitcoin is a game changer because 1/unlike elastic money it does not facilitate FRB 2/ banking is no longer reserved to a cartel

bingo.

Interestingly, over the past year and a half or so I've gone through a nearly identical change.  Very cool.

Cool. Talking about changes in the last year and a half or so (since I found bitcoin, or the other way around): I've been educated by the bitcoin crowd on a lot of topics and it really changed my view in many areas. I have learned, among other things, about:

• money (functioning and history)
• libertarianism, anarcho-capitalism
• economics and functioning of markets, esp. austrian school
• the "greatest theft of a all times" and debt-slavery
• media and journalism
• politics, corporatism and the american empire
• human nature (greed, fear, trolling, trust, brainwashing, swarm behaviour,...)
• the importance of liberty, sound money and truly free markets

I want to hereby thank the many great and knowledgable minds in this community for helping me understand many things I only knew cloudy half-truths about before.

You guys are awesome!

That seems right.  Unless I'm missing something, there are two reasons that people hold fiat with banks today: (1) security (safer than keeping all of your money in cash in the house due to risk of burglary, fire, etc.) and (2) facilitation of digital / at-a-distance exchange (e.g., debit cards and online payments).  It's certainly not for the pathetic interest you're likely to earn on your deposit.  But a big part of the reason that banks are safer is because of government intervention, e.g. deposit insurance.  Nobody worries about a bank run anymore.  And that's why you allow the bank to lend out your deposit -- which is really a loan by you to the bank.  In an unregulated market, if your only interest was security (and you didn't want to expose yourself to the inherent risk of a fractional reserve-type institution), you'd rent a safe.  The safe storage place vs. lending aspects of banks have gotten lumped together but they don't have to be.  With Bitcoin, you don't need the security aspect.  It's relatively easy to secure your own wallet. And you also don't need to have an account with a third-party to facilitate digital / at-a-distance exchange.  That's what Bitcoin does!  So the only reason you'd have to lend your money to a bank-like institution operating on fractional reserve basis would be for the interest you could earn.  But your deposit (i.e. loan) won't be backed by federal deposit insurance so chances are you're going to demand a relatively high rate of return.  And even if we see a lot of those types of institutions spring up, it doesn't seem like they'll increase the money supply (at least not significantly).  From the wikipedia page on fractional reserve banking and bitcoin:


Bitcoin is digital cash.  It seems to me that a Bitcoin demand deposit is very unlikely to be treated as the "equivalent" of cash (and thus add to the money supply) in the absence of government-guaranteed deposit insurance / "lender of last resort" interventions.  

Thoughts?

+1, I have to agree with you on the OP.

Learning about the banking industry gave me a great insight into how it can provide a great service if it is managed correctly. The perception of them being evil is in my mind due to a lack of understanding of how the banking system works.

I believe if FRB is explained clearly and governed correctly, there is no reason for anyone to worry about the service they offer:

• In order for a bank to lend, it has to hold deposits. To get deposits, it will offer its customers interest.
• To make money for its customers, the bank will lend some of the deposits out and charge interest on its loans.

Black and white right? Now let me explain in simple terms how everybody is a winner:

• A good bank will guarantee the safety of money that customers have deposited.
• A bank takes on risk when it lends as customers can 'default' and not pay back their loans.
• This is a well understood risk and a banks charge set their interest rates to make profits to cover potential losses.
• If all of the loans are paid back with interest, then the bank will have earned enough to pay its customers who have lent the bank money + more profit for themselves. This is a good thing as they have provided all parties with a good honest service.

And now how greed makes it all goes wrong:

• A good bank for safety will keep a set amount of depositors cash for security. This is called a 'Reserve Ratio' (sometimes Cash Reserve Ratio).
• It will not use this reserve to lend to others. The higher the bank's reserve, the safer it is deemed to be.
• Greed - For a depositor to make more money on what they lend, the bank needs to make more money.
• For the bank to make more money, it has to lend more.
• The more a bank lends, the lower the reserve will be.

Fear:

• If a negative world event happens, people worry and start withdrawing their savings.
• For immediate withdrawals, they can fulfil most requests using its cash reserves.
• If the fear spreads and everybody wants to withdraw their cash, problems will arise when the cash reserves it holds run out. (and this in the real world is where the GFC starts...)

Banking can be a good honest business as long they are careful. How can they be careful?

Well that is also simple. Ensure that you hold a high enough Cash Reserve Ratio and don't get greedy.

In the US, banking policy (enforced by the BASEL accords) states that your CRR should be around 10%. This is quite frankly ridiculous and was in my mind the sole root cause of the entire financial system collapsing.

Why on earth a bank would lend out $900,000 on $1,000,000 of deposits is stupid. Given that a bank's duty is to understand and manage risk, the risk of somebody defaulting on a payment has always been there and its not new.

Historically in the fiat market, the CRR used to be around 30% which created a robust banking system with plenty of monetary flow to ensure a healthy economy.

I would be fully behind any bitcoin bank who provides an honest deposit and lending service with a CRR of 50%. This should yield reasonable profit for all parties and will be very safe if managed well.

thanks for your cool post, Seal.


How do you ensure they hold a high enough Cash Reserve Ratio and don't get greedy, though?

Well, that's also simple: by using fear (fear is stronger than greed): Remove lender of last resort bullshit and let the bank die in case it fucks up (no bailouts). Result: their depository customers (or their insurer) will demand higher reserve ratio (by fear of losing funds) and the bank will comply (by fear of death and competition).

Entities can act quite responsibly exactly if they know they will suffer the consequences of their actions. (meaning they will not act responsibly if they don't have to suffer consequences)

yup, then fear and panic caused the infamous bank runs and chaos (probably instigated).

Then the solution was presented, tadaaa: A central bank. The FED/EZB. It was meant to "regulate" the banks and the amount of money supply by being able to determine an authoritative key interest rate.

Today we know centralization is bad. It makes everything even worse. We have to go back and think of different solutions.

Guess a better solution would be some kind reinsurance system for banks against bank runs. Or they must take loans themselves from other banks in order to pay bank runners out. But what if there is a run on every bank? In my naive world view, every bank runner will be satisfied because most money is in circulation *somewhere*, it should be a zero sum game. Businesses that took loans use that money to pay their employees etc. There was never a need for creating money out of thin air by stretching balances.

+1 on emphasis above. Let the banks figure out insurance themselves (it's part of their business) and let the market judge how well they do it (transparency).

Any problems with that approach?

I think lending without sufficient collateral should be avoided at all cost.

The moment collateral doesn't suffice, you need to get the government and the legislative to intermediate in a private transaction. Should be a last resort and not a common occurrence.

If you don't have anything for collateral then I guess you should work your way up little by little without borrowing. I have never taken any loans whatsoever, and I have bought nothing on credit. I've given and received small-ish amounts of money from my family (particularly from my parents as I grew up, they paid for my food, shelter and education).

I really cannot see how cannot this work for anybody unless they're simply trying to punch above their weight.

+1

This is the biggest lesson learned in the housing crisis. Mortgages were given that were more then the value of the homes. Once repossessed, the bank couldn't even sell it to cover their losses as it was worth less than it should have been valued.

Over valued house = people being greedy (always wanting their home to be valued more)

With bitcoin it's actually possible to monitor how much of your funds are left as a reserve with your bank.
If you transfer 100BTC to your bank account, and have selected a 50% CCR option, the balance of that account should never go below 50BTC.
Sure you might not get much interest in this case but you can chose your risk vs interest payment on an individual basis.
The account/wallet monitoring of the blockchain could be an app you run yourself  or a 3rd party service.

I don't think that's true. The reserves are there for a reason...

Assume both you and I put BTC 100 into the bank. The bank invests 50 of your BTC and 50 of my BTC, 100 BTC in sum, the other 100 it keeps as reserve, so it fulfills the 50% reserve requirement.

Now I go ahead and withdraw 80 BTC. Now 30 have to come from "your account", the bank now has to liquidate some of its investments because its reserve ratio dropped below 50% (only 30 BTC for 130 deposits), but in the meanwhile (that takes some time), the reserve is used to pay me my 30 BTC. Correct?

yes you're right. So the term "CCR" is incorrect when used for an account like this.
This method does let the customer choose the level of risk vs payback. A sliding scale between a storage/safekeeping and investment/returns.
It would be up to the bank what they keep in reserve to pay out the full amount on withdrawal.

Perhaps if all the accounts with corresponding bitcoin addresses was published a real CCR monitor system could be designed?

Hehe, but how is this implemented? When push comes to shove, the customers with lower risk level get their funds back first?


What's the aim again here? You want to make auditable that banks keep the promised reserve ratio? Per account? I'm unsure I get the idea. Kinda confused, probably too much sun today ;)