There could be much more than 21'000'000 bitcoins...

[Come-from-Beyond]

...because of fractional reserve.

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

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

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

[1715105514]

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[ArticMine]

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

[BladeMcCool]

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

[ArticMine]

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

It depends on how those institutions are designed. If they are designed with contractual withdraw limits/time frames and are open about their fractional reserve, paying interest on deposits, and allowing public audits via the block chain, I see no reason why they can't exist.

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

[Come-from-Beyond]

While fractional reserve may eventually happen in the Bitcoin economy.

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

[JoelKatz]

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

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

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

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

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

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

Him: Yeah. Lots.

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

Him: Yeah, about that.

Me: 2% is 1 in 50.

Him: *lightbulb goes on*

[dissipate]

While fractional reserve may eventually happen in the Bitcoin economy.

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

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

[the_thing]

While fractional reserve may eventually happen in the Bitcoin economy.

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

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

[Come-from-Beyond]

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

[the_thing]

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

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

[benjamindees]

Pirate's ponzi scheme is a good example of "perpetuum mobile" that generates bitcoins out of thin air.

No.   



“An Indian born economist once explained his personal theory of reincarnation to his graduate economics class,” Paul Krugman writes in the opening paragraph of his Preface to Peddling Prosperity. “‘If you are a good economist, a virtuous economist,’ he said, ‘you are reborn as a physicist.’”

[the_thing]

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

[lonelyminer (Peter Šurda)]

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

[JoelKatz]

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

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

[Stephen Gornick]

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

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

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

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

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

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

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

While fractional reserve may eventually happen in the Bitcoin economy.

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

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

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

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

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

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

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

[Technomage]

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

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

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

[lonelyminer (Peter Šurda)]

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

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

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

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

[LeonGeeste]

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

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

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

[JoelKatz]

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

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

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

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

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

[lonelyminer (Peter Šurda)]

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

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