Fractional Reserve Bitcoin

[dpbaril]

Since I'm still a Newbie I am unable to join in the conversation at https://bitcointalk.org/index.php?topic=22553.msg283403#msg283403 which, in any case, is pretty old - I'll post my comment here... 

The point that seemed to be missed in that thread, is that a fractional reserve bank actually lends multiples of its reserves not a fraction of it. I do not see how it is possible for the bank to lend out more bitcoin than it actually has on deposit. If people start to accept bank obligations based on a reserve of BTC, those obligations (notes?) are not BTC - the bank has simply created another currency based on its reserve of BTC. The waters might get muddied if the bank obligations were denominated in BTC but the bank would run into liquidity problems as soon as the borrowers spent the loan since they would have to transfer actual BTC.

Am I missing something?

[1714115362]

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[1714115362]

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[rosatambo]

You're not.  You can't print bitcoins, so you can't give out more than you have.  Anyone claiming to do so is running a ponzi scheme, pure and simple. Let's try to keep the HYIPs off bitcoin, ok?

[Kluge]

Banks only lend out multiples of their reserve because they're only required to hold ~10% of their deposits on-hand as cash or something roughly as fungible as cash. They're still only lending out a fraction of their assets (including deposits), not multiples, so it's not magically multiplying money. They don't have $5m deposited, $500k free-and-clear as equity, then go around lending out $20m or something. Depositing into a bank is basically giving them a loan for them to take arb profit on. The goal of FRB law is to set a reasonable percentage of deposited funds which need to be able to be covered on any day, with the intent to prevent bank runs and keep everyone's deposit fungible, while also allowing banks to profit and give something back to customers (free checking, interest, subsidized transactions, etc.). Whether or not the majority of consumers know that or not doesn't really matter so long as the FDIC/NCUA has very low minimums in deposit insurance coverage (though that obviously introduces more moral hazard).

You can obviously do the same with Bitcoin, and I was concerned about MtGox's ability to do so ("issue debt notes") with "GoxBTC," but Gox recently pulled USD/BTC code functionality, so...

[wiggi]

You can't print bitcoins

If you don't find someone who lends them to you, there could still be a futures market.

For example, some big bank sells Btc futures (using dollars for collateral), some ETF buys them and people can
"invest" in Bitcoin without actually driving the price...

[DannyHamilton]

Am I missing something?

Here is a scenario:
Imagine total of BTC1000 in actual currency exists...

Alfred owns all of it an deposits this BTC1000 into an on demand checking account at a bank.
(Total bank deposits BTC1000, Total bank loans BTC0, Reserve on hand BTC1000, Reserve 100%)

Betty receives a loan from the bank of BTC800.
(Total bank deposits BTC1000, Total bank loans BTC800, Reserve on hand BTC200, Reserve 20%)
So the bank has loaned out a "fraction" of their deposits, not a "multiple" of their deposits.

Betty uses the BTC800 to purchase something from Charlie
Charlie deposits the BTC800 that he just received from Betty into his own checking account.
(Total bank deposits BTC1800, Total bank loans BTC800, Reserve on hand BTC1000, Reserve 55%)
Notice the BTC1800 in deposits at the bank from BTC1000 currency limit. This is how "fractional reserve" multiplies money.
Notice the bank still only has BTC1000 in reserve on hand.  There is no increase in the actual amount of bitcoins in existence, but if you add up how much each individual thinks they have, the total is greater than the BTC1000 limit. Meanwhile, nobody believes they have accepted a bitcoin backed banknote, since they can all see that they've actually received real bitcoins that they deposited at the bank.  Lets carry the process forward and see what happens.

Denise receives a loan from the bank of BTC640. (re-loaning out the same money that was already loaned out to Betty, and deposited by Charlie)
(Bank deposits BTC1800, Bank loans BTC1440, Reserve on hand BTC360, Reserve 20%)

Denise uses the BTC640 to purchase something from Elliot
Elliot deposits the BTC640 that he just received from Denise into his own checking account.
(Bank deposits BTC2440, Bank loans BTC1440, Reserve on hand BTC1000, Reserve 41%)

Francine receives a loan from the bank of BTC512. (re-loaning out the same money that was already loaned out to Betty and Denise)
(Bank deposits BTC2440, Bank loans BTC1952, Reserve on hand BTC488, Reserve 20%)

Francine uses the BTC512 to purchase something from George
George deposits the BTC512 that he just received from Francine into his own checking account.
(Bank deposits BTC2952, Bank loans BTC1952, Reserve on hand BTC1000, Reserve 34%)

Hanna receives a loan from the bank of BTC409. (re-loaning out the same money that was already loaned out to Betty, Denise, and Francine)
(Bank deposits BTC2952, Bank loans BTC2361, Reserve on hand BTC591, Reserve 20%)

Hanna uses the BTC409 to purchase something from Ivan
Ivan deposits the BTC409 that he just received from Francine into his own checking account.
(Bank deposits BTC3361, Bank loans BTC2361, Reserve on hand BTC1000, Reserve 30%)

At this point we already have BTC3361 in deposits from that single BTC1000.  Alfred, Charlie, Elliot, George, and Ivan all believe that they are the true owners of this money since they each received real bitcoins and then deposited it into their own checking account.  Where did the extra BTC2361 come from? Meanwhile the bank has re-loaned out the same money over and over without a single cent of it having been repaid yet.  The bank's "fractional reserve" never fell below 20%, and yet somehow they've managed to loan out "multiple of its reserves".

This process can continue over and over, expanding the money supply until there is BTC5000 in deposits, since the maximum the bank can ever have in reserve is the full BTC1000 of physical cash in existence.  This would result in BTC5000 in deposits, BTC4000 in outstanding loans waiting on repayment, and BTC1000 in reserves.

[Pale Phoenix]

I believe OP is correct... but we are getting hung up on semantics.

When the bank lends out $800 of its first $1000 deposit, that $800 gets deposited either in the same bank or another bank; for the sake of simplicity, let's say it is put back into an account at the lending bank.

Now the bank has $1800 on deposit (liabilities) and $800 in outstanding loans (assets). Next, they lend out $1500 of their deposits and again that money is deposited back into the same bank, giving them $3300 in deposits (liabilities) and $2300 in outstanding loans (assets). Wash, rinse, repeat.

In this way, banks actually CREATE money when they issue loans. Certainly, every loan is not deposited back into the same bank, but they are almost always deposited back into SOME bank in the Federal Reserve system, so the total amount of money in circulation (called M1/M2 or M3 depending on which kinds of deposits are included) increases as loans are made. As loans are paid back, money is removed from circulation and over time a certain equilibrium is created.

It is the job of the central bank to control the aggregate amount of money in circulation with the tools at its disposal, such as the interest rate it charges regular banks for loans to meet their fractional reserve requirement.

Here's a graphic that explains how banks create money: http://en.wikipedia.org/wiki/File:Money-creation.gif

The difference with Bitcoin is that it can't be CREATED by making loans, only by mining. In this way it is more akin to the cash and coin printed by the Federal Reserve, as that can't be multiplied through lending either, unless it is exchanged for credits in a bank.

[Dasneko]

You are forgetting something. Because Bitcoins are connected to the rest of the market they just have to borrow other currencies, convert them into bitcoins then invest them. Or the other way around whatever the case may be.

[jamesgarfield]

Fraction reserves Bitcoin? huh