Fractional reserve banking

[BitFutex]

Is fractional reserve banking (i.e. lending based on a fractional reserve) incompatible with BTC?

[BigJohn]

It's still possible, but to a much lesser extent.

An organization could offer a credit-line that's backed by Bitcoin. It could then extend that credit several-times over its actual reserves of Bitcoin. I would suspect that if anyone tried to do that though, it would be found out real fast and their reputation will suffer for it. I don't believe it will be possible to over-extend the credit to such degrees as we're seeing today with fiat, without the benefit of the printing press that fiat has.

[World Commerce]

Is fractional reserve banking (i.e. lending based on a fractional reserve) incompatible with BTC?

Fractional reserve banking is inflationary money--Bitcoin is not. Bitcoin is not a bank. Bitcoin is incompatible with fractional reserve banking.

[fixyourtech]

It would be pretty hard to lend 10 BTC for ever BTC in a bank.

[barbarousrelic]

FRB would be possible but it would require a lot of people to keep their Bitcoin in Bitcoin banks. I don't see this happening, because it's incredibly easy and, if you're halfway smart, just as secure to keep your Bitcoin on your home computer wallet.

[peterz]

The FRB on bitcoin is technically possible, but it is not sustainable, and would not exist in the long run.

The explanation:
1) Yes you can create bitcoin bank doing FRB, i.e which will claim it stores all your bitcoins, and at the same time uses fractions of them (hence FRB) for their own investment, thus increasing the money supply in short run. This is a fraud, which FRB is based on.

2A) With fiat currencies, the FRB fraud could be sustained, because in case of bank run, there is a central bank (Federal Reserve in the US), which will step in, and print new fiat money to cover the missed reserves. Thus increasing the money supply in the long run.

2B) With bitcoin it is not possible to sustain the FRB fraud. I.e. in case of bunk run, there is no central bank to create new bitcoins, that's not possible. Therefore such bank will crash, and money supply will stay same in the long run.

One can say bitcoin promotes 100% reserve banking, it of course does not prevent FRB, but the free market would always bring down such institutions sooner or later, rendering such attempts unprofitable.
Bitcoin is a brilliant concept!

[Zeke_Vermillion]

seems like a bad idea, adding leverage to an already volatile commodity

[NsxV2rAt5E]

Fractional reserve banking is inflationary money--Bitcoin is not. Bitcoin is not a bank. Bitcoin is incompatible with fractional reserve banking.

Could you explain this some more?
Is bitcoin incompatible with any kind of banking at all?

Is there any banking that is not fractional reserve banking?

Is bitcoin incompatible with loans, interest, etc.?

Let's say I deposit 100 bitcoins at the bitcoin bank with 1% interest.  The bank lends 90 bitcoins to someone else for 2% interest.  Between the two of us, we now have 190 bitcoins.  In reality there are only 100 bitcoins that can be used for bitcoin transactions at any time, so this is called fractional reserve banking.  The extra 90 bitcoins are a promise to pay someone at a later date (e.g. when I ask for my deposit back).

A year later the borrower pays back the loan by turning in 91.8 bitcoins to the bank.  I withdraw 101 bitcoins from the bank and the bank ends up with 0.8 bitcoins profit.  Is there something wrong with this scenario?  Is it any different from conventional currency?

[peterz]

<Let's say I deposit 100 bitcoins at the bitcoin bank with 1% interest.  The bank lends 90 bitcoins to someone else for 2% interest.  Between the two of us, we now have 190 bitcoins.  In reality there are only 100 bitcoins that can be used for bitcoin transactions at any time, so this is called fractional reserve banking.  The extra 90 bitcoins are a promise to pay someone at a later date (e.g. when I ask for my deposit back).

A year later the borrower pays back the loan by turning in 91.8 bitcoins to the bank.  I withdraw 101 bitcoins from the bank and the bank ends up with 0.8 bitcoins profit.  Is there something wrong with this scenario?  Is it any different from conventional currency?>

What you described is bank using FRB, which won't work in the long run.
The question is you need ask. What will happen when you try to withdraw your 100 bitcoins from such bank, but the bank has only 10 of them, because the 90 has lent?
There are few lessons:
1) Such bank can't afford to keep lending your bitcoins, because there is no cental bank which would create the missing bitcoins on demand;
2) In reality there is always 100 of bitcoins, never 190, and never will become 190 again because no central bank can print the missing 90 bitcoins.


What I say the banking of BTC is fully possible, but shouldn't be based on FRB. It should be 100% reserve banking. People don't understand the concept of 100% banking because currently the FRB is enforced by governments all over the world.
With 100% reserve bank, there would be no interest to earn. Because it would be a true bank, more likely you would pay fees for storing your bitcoins there. The benefit is that the bitcoins itself would no lose value, and would always appreciate in long run, thus keeping your savings safe.

[rothschild_666]

Fractional reserve banking doesn't require a central bank to exist or work, but it does need something physical that backs whatever the bank is holding/issuing.  But since 1913 it has implied a central bank exists.

You could create a bank where deposits are denominated in BitCoins and depositors receive some interest for keeping their coins in the bank instead of a private wallet.  There are so many issues with this that it seems inconceivable. 

FRB can work if the bank actually holds considerable reserves for it's liabilities.  This implies fewer pieces of money or dollars or whatever you want to call it being used in the economy.

[PrintCoins]

This absolutely can work, and has happened (or at least I suspect it has).

mtgox keeps all of its bitcoins in its wallet and not tied to any particular users. It maintains user account balances in its database. It has been hacked before and I suspect lost a portion of its assets while maintaining user account balances. It also may have had occasional theft, accounting errors, and perhaps some investment spending using bitcoins. So if user account balances total 1000 bitcoins, it is totally possible that mtgox only has some fraction of those bitcoins (and USD) available to pay out. I suspect that many new investors in bitcoins don't even have a wallet outside of mtgox as they are just in the speculation game, so it makes it even easier for mtgox to maintain a only a fraction of the balances of the accounts in its reserves.

Now, this doesn't mean that they are really doing this, but I have no reason to believe that they are not, and they are not the bastion of transparency. Heck, if they sold off 50% of their stockpile into cash right now, they would have a lot of fiat to work with, and it would be likely that users would never be the wiser. Maybe they could play even riskier and keep only 10% of the bitcoins.

What makes this possible scenario interesting is that this actually inflates the money supply. If there were only 1000 bitcoins in existence, and 500 were in gox balances, and gox spent 400 of them keeping 100 in reserve, there would be in effect 1400 bitcoins in circulation, even though there are only 1000 real bitcoins.

As someone on the sidelines I eagerly wait until there is a run on mtgox and keep a stockpile of popcorn on hand. Only then will we see what is going on in their backrooms.

[NsxV2rAt5E]

With 100% reserve bank, there would be no interest to earn. Because it would be a true bank, more likely you would pay fees for storing your bitcoins there. The benefit is that the bitcoins itself would no lose value, and would always appreciate in long run, thus keeping your savings safe.

What about loans?  The point of FRB is that it can be used to lend money to individuals or businesses.  Is bitcoin not suitable for lending?

Ok, you don't need FRB to lend money, but it surely increases the amount that you can lend and therefore decreases the cost of lending.  Otherwise lending will get much more expensive.  Will it not?

As for bank runs, they are a problem with the current banking system too.  That's why Cyprus shut the banks for several days.  If there is a bank run with FRB, people may lose their deposits, no matter if they were in euros or bitcoins.

Is there going to be a cryptoloaning technology invented that does not require banks?  I suppose this would be something like crowdfunding, but safer in terms of tracking where your loan goes and possibly getting part of it back, if necessary.

[PrintCoins]

With 100% reserve bank, there would be no interest to earn. Because it would be a true bank, more likely you would pay fees for storing your bitcoins there. The benefit is that the bitcoins itself would no lose value, and would always appreciate in long run, thus keeping your savings safe.

What about loans?  The point of FRB is that it can be used to lend money to individuals or businesses.  Is bitcoin not suitable for lending?

Ok, you don't need FRB to lend money, but it surely increases the amount that you can lend and therefore decreases the cost of lending.  Otherwise lending will get much more expensive.  Will it not?

As for bank runs, they are a problem with the current banking system too.  That's why Cyprus shut the banks for several days.  If there is a bank run with FRB, people may lose their deposits, no matter if they were in euros or bitcoins.

Is there going to be a cryptoloaning technology invented that does not require banks?  I suppose this would be something like crowdfunding, but safer in terms of tracking where your loan goes and possibly getting part of it back, if necessary.

People give and ask for loans frequently on the forums (I think there is a subforum for it). Dealing with credit and fraud protection in an anonymous system using a currency with no legal backing is troublesome. Whoever figures out how to do it well will be able to do quite well, but it definitely is a risky business.

[KarmaShark]

I do not see these two competing systems co-existing together for the long term. Guess which one I am going long on? : )

[PrintCoins]

I do not see these two competing systems co-existing together for the long term. Guess which one I am going long on? : )

What two competing systems? FRB will exist regardless of whether the asset is $, BTC, or metal.

[drhobomanxxiii]

FRB is easy to create with Bitcoins... PrintCoins described the scenario rather well with his Mt. Gox example.

If you have a Bitcoin bank, (I believe this will happen for security reasons, as well as for facilitating other services,) then if that bank loans off a part of their reserves while still holding accounts (debts) to its depositors, then they're engaging in FRB.

I'm actually a big fan of that idea, because in that case such a bank would have a market competing with it for the same services, and a very valuable piece of information to use for choosing between banks will be its reserve rates. If the bank is set up correctly, its reserve rate can be well known by utilizing "green" addresses (well known addresses) for all deposits and withdrawals, as well as storage.

In such a scenario, the reserve rate can be calculated by looking at deposits to the deposit address, transfers to and from the storage address (probably held in cold storage,) and withdrawals from a withdrawal address to find the bank's liabilities and on-hand reserves. A fourth address could be used as a gateway within the bank for managing loans (with each account being a separate address known only to the bank and borrower,) whereas transfers to and from anything but the storage, deposit, or withdrawal accounts would be the bank's loan assets.

Given that address construction, all you need to do then is to calculate liabilities (what's held on account,) and weigh it against the calculated reserves to find the reserve rate, then you can also check that against the loans that you can also calculate from the loan address. Using this full system, the bank's average interest rates are known publicly, both for loans and deposits, in addition to having a publicly known reserve rate.

That would be an extremely good financial institution for an economy to have.

[rothschild_666]

In such a scenario, the reserve rate can be calculated by looking at deposits to the deposit address, transfers to and from the storage address (probably held in cold storage,) and withdrawals from a withdrawal address to find the bank's liabilities and on-hand reserves. A fourth address could be used as a gateway within the bank for managing loans (with each account being a separate address known only to the bank and borrower,) whereas transfers to and from anything but the storage, deposit, or withdrawal accounts would be the bank's loan assets.

Given that address construction, all you need to do then is to calculate liabilities (what's held on account,) and weigh it against the calculated reserves to find the reserve rate, then you can also check that against the loans that you can also calculate from the loan address. Using this full system, the bank's average interest rates are known publicly, both for loans and deposits, in addition to having a publicly known reserve rate.

That would be an extremely good financial institution for an economy to have.

excellence!  the lack of information (and low reserve requirements, which only exacerbates the situation) regarding real life banks' balance sheets is one the causes of FRB's "issues".

ironic that the free flow of information about BTC transactions and addresses is supposed to remedy such things and not bring the system down?

[peterz]

<What about loans?  The point of FRB is that it can be used to lend money to individuals or businesses.  Is bitcoin not suitable for lending?

Ok, you don't need FRB to lend money, but it surely increases the amount that you can lend and therefore decreases the cost of lending.  Otherwise lending will get much more expensive.  Will it not?>

Nope, there is no problem in lending bitcoins. The FRB doesn't make lending possible, FRB only by fraud allows banks to do the lending instead of the rightful  owners. Despite the fact, that it decreases the lending costs, but it also increases overall prices, so in sum there is no benefit. Actually there is a net loss of what bank earns on it while not being a rightul owner of the funds.

So with 100% the lending is possible, yes the lending costs will be higher, but at the same time the amount needed to lend will be much lower, since there won't be any induced inflation caused by FRB.
In sum, the 100% reserve banking is much more beneficial for the individuals (both borrowers and lenders), the FRB is beneficial for banks only (they earn interest on things they don't own damaging all other participants on the way).

[peterz]

<I do not see these two competing systems co-existing together for the long term. Guess which one I am going long on? : )

What two competing systems? FRB will exist regardless of whether the asset is $, BTC, or metal.>


Nope, the FRB could survive a longer run only if there is an entity of last-resort-lender, which has an ability to create new units of money out of nothing (i.e. in current fiat money systems - those are the central banks - which uses that to do the bailouts of otherwise failed institutions on regular basis).

With bitcoin no such entity like central bank could possible exist. There is no way to create new bitcoins on demand out of nothing, that's the beauty of it.

[peterz]

<This absolutely can work, and has happened (or at least I suspect it has).

mtgox keeps all of its bitcoins in its wallet and not tied to any particular users. It maintains user account balances in its database. It has been hacked before and I suspect lost a portion of its assets while maintaining user account balances. It also may have had occasional theft, accounting errors, and perhaps some investment spending using bitcoins. So if user account balances total 1000 bitcoins, it is totally possible that mtgox only has some fraction of those bitcoins (and USD) available to pay out. I suspect that many new investors in bitcoins don't even have a wallet outside of mtgox as they are just in the speculation game, so it makes it even easier for mtgox to maintain a only a fraction of the balances of the accounts in its reserves.

Now, this doesn't mean that they are really doing this, but I have no reason to believe that they are not, and they are not the bastion of transparency. Heck, if they sold off 50% of their stockpile into cash right now, they would have a lot of fiat to work with, and it would be likely that users would never be the wiser. Maybe they could play even riskier and keep only 10% of the bitcoins.

What makes this possible scenario interesting is that this actually inflates the money supply. If there were only 1000 bitcoins in existence, and 500 were in gox balances, and gox spent 400 of them keeping 100 in reserve, there would be in effect 1400 bitcoins in circulation, even though there are only 1000 real bitcoins.

As someone on the sidelines I eagerly wait until there is a run on mtgox and keep a stockpile of popcorn on hand. Only then will we see what is going on in their backrooms.>


That is not FRB, if something got stolen from mtgox, and they are able to cover the losses that's only keeping their business afloat. They could only cover such loss if they owned more bitcoins by themselves (their own reserves), possible earned from their business.
(If somebody steals portion of you money, and you still pay your rent, that is not FRB.)
Every business and individual have to take care of protection of their assets, doesn't matter of what kind, if they were stolen that's not FRB, the stealing doesn't increase the total number of assets in the economy.

On the other hand FRB is based on a fraud, which would happen if mtgox used the bitcoins of the users for their investing activities, trying to make profit on that, and at the same time claiming all deposits are available for users.
I am sure if they tried to go that path, they would not last long.

All I am saying the FRB on bitcoins is possible, but can't work in long run, because of no lender-of-last-resort who would save insolvent institution.