Bitcoin major fail - doesn't allow credit creation (aka deflationary currency)

[molecular]

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.

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).

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[myrkul]

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.

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.

[molecular]

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.

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.

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

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.

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))

[myrkul]

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.

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

[johnyj]

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.

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.

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

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

[myrkul]

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.

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.

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

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

And what happens when that $0.90 gets deposited elsewhere?

[johnyj]

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

[myrkul]

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

Thank you.

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

[odolvlobo]

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.

[Rassah]

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.

[bitfreak!]

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.

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.

[molecular]

Bitcoin is purposely designed to be very difficult to create by requiring a lot of energy to create them

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.

[molecular]

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.

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).

[johnyj]

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

[MoonShadow]

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.

[johnyj]

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

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

[caveden]

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

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.

[johnyj]

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

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

[myrkul]

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

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.

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.

[MoonShadow]

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

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.

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.