Is credit possible with Bitcoin? Explain.

[Razick]

Anything can be abused.
Fractional reserve doesn't seem possible with BTC, no way you could lend btc you didn't have. But it would be possible to create a system that lent $ (or some other fiat) based on holdings of BTC. I don't see why anyone would, but thats a different question.

Fractional reserve banking doesn't allow lending money that doesn't exist, it just permits lending money that you don't personally have even though someone else does.

It is possible to do fractional reserve banking with bitcoin.  Fractional reserve banking does allow to you to lend money that doesn't exist-- indeed that is exactly what banking is all about.  The banks lending more money than they have on deposit is how money is created!

That's the effect, but it's not like an individual bank has $100 in deposits and loans out $1,000. That is the symptom, but it's not that simple  if I understand correctly.

[weisoq]

Bitcoins, Fractional Reserve Banking, and Private Currencies

[countryfree]

Fractional reserve banking would be difficult, but that is good. Banking would go back to how it was before that was invented, with bankers only lending the money they actually own. Not a tiny fraction. I had wished for many years that fractional reserve banking would become illegal (the financial system would be way healthier,) and bitcoin could finally make that happen.

It would still be possible to get a credit by putting a mortgage on the house.
It would also be possible to get a financial institution to buy a car, and then rent it to its customer.

[herzmeister]

Bitcoins, Fractional Reserve Banking, and Private Currencies

It says: "Building up the networks which would allow fractional reserve banking requries a transmission system which is nearly impossible to develop for bitcoin-like products, because it relies on adoption."

Again: Ripple.

[weisoq]

Bitcoins, Fractional Reserve Banking, and Private Currencies

It says: "Building up the networks which would allow fractional reserve banking requries a transmission system which is nearly impossible to develop for bitcoin-like products, because it relies on adoption."

Again: Ripple.

I agree with the nature of bitcoin not supporting credit. I don't know enough about ripple to give an informed opinion, although it seems incredibly complicated for mass take up and lifts the lid on a great deal of monetary and credit dynamics that I'm not sure people yet want to understand or hear. As with bitcoin I suspect any best-case long term future of ripple will be as a conduit for other assets and currencies, with little to no value apportioned to the backing concept except as a transaction means. And as I'm sure must have been debated before on this forum, although technically via banking/savings/investment I am already facilitating 'ripples' of my credit throughout the system, I'm not at all sure how keen people will be to overtly mix business with pleasure and peers once they've worked it out.

[keelba]

I had wished for many years that fractional reserve banking would become illegal (the financial system would be way healthier,) and bitcoin could finally make that happen.

It is very possible that the economy would be healthier. On the other hand, it's very possible that you wouldn't have many of the things you have today. The system of fractional reserve banking allows businesses and governments to do things they otherwise wouldn't have while the money is free flowing. Sure, there is always a pull back and this causes the "business cycle", but we always progress as a result. You would probably be much healthier too if all you did was stay home all day and workout, eat healthy foods, and avoided all things such as smoke, tobacco, alcohol, microwaves, television, cell phones, etc. But you would also live a very boring life. We tolerate occasional hangovers because it is fun to go out and let loose once in a while.

I'm not trying to say I'm all for fractional reserve banking. But it is something to think about. I actually think we have progressed too far, too fast in regards to technology and it's time to settle down for a while. I would be all for a slow, healthy, and stable economy for several decades.

[gendal]

The BlockLedger makes things very difficult when you can follow the assets of any entity. A bank/broker would have to make their deposit address public, and then you follow the ledgers trail

*This* is the key insight.

It is completely obvious that fractional reserve banking would be possible with Bitcoin but the transparency of the Blockchain makes it qualitatively different to the situation with, say, gold.

The Blockchain would make it possible to see all the deposits a "bank" had taken in and all the loans it had made, as well as the interest payments as they came back, and repayments of principal.

Sure - some of this might be obfuscated but I would expect market pressure to force banks to be as transparent as possible.

But that then creates a huge issue: everybody can calculate the bank's reserve ratio, can infer its loan and deposit terms and estimate default rates, etc.   An optimistic analysis would say that this would encourage conservatism and build confidence.  BUT... the moment the bank suffered a loss or a borrower stopped paying interest, *everybody* would know and a run would surely start within moments.

[Rygon]

Credit can and has happened already with bitcoin. Look in the loan forum, any one of the many ponzi scams, or leveraged trading sites. I'd be willing to bet that some fractional reserve banking has happened also. Even though the blockchain is public, I have no knowledge of anyone doing a serious audit on MtGox or any of the major exchanges. There is a lot of money sitting on those exchanges waiting for a spike in the price to sell. Although I have no reason to believe there's fractional reserve banking going on, it is trivial to implement. All it takes is using some % of deposits to loan out or go manipulate the market a little bit.

[beeblebrox]

That's the effect, but it's not like an individual bank has $100 in deposits and loans out $1,000. That is the symptom, but it's not that simple  if I understand correctly.

That is what they do.

[countryfree]

I had wished for many years that fractional reserve banking would become illegal (the financial system would be way healthier,) and bitcoin could finally make that happen.

It is very possible that the economy would be healthier. On the other hand, it's very possible that you wouldn't have many of the things you have today. The system of fractional reserve banking allows businesses and governments to do things they otherwise wouldn't have while the money is free flowing. Sure, there is always a pull back and this causes the "business cycle", but we always progress as a result. You would probably be much healthier too if all you did was stay home all day and workout, eat healthy foods, and avoided all things such as smoke, tobacco, alcohol, microwaves, television, cell phones, etc. But you would also live a very boring life. We tolerate occasional hangovers because it is fun to go out and let loose once in a while.

I'm not trying to say I'm all for fractional reserve banking. But it is something to think about. I actually think we have progressed too far, too fast in regards to technology and it's time to settle down for a while. I would be all for a slow, healthy, and stable economy for several decades.

I wouldn't mind living without many things most people take for granted, in fact I already have a very simple life. I haven't had a TV in my home for 20 years, but in the meantime, I've seen my friends throwing away their VHS recorders, then their DVD recorders, because they're now buying Blueray recorders and new larger TVs to go with those. I understand this is progress, but is that really useful? I wish there was less money around, so that people (and governments) would focus on the essential, and not waste time on superficial things. Who needs business cycles? We have seasons, birthdays, natural cycles, it's more than enough to avoid a boring life.

[Stampbit]

I would only get a bitcoin credit card if could get a low low APR of 29.98%. And it has to be named after a precious metal.

[EmperorBob]

So in a classic sense, MB (Monetary Base, the set of notes and coins in circulation or held as reserves) is the bitcoin network, and trying to increase it beyond 2.1E7 is a hard fork.
However that says nothing about M2 and friends. Partial reserve lending is possible, although I doubt we'll see take hold until the value stabilizes and the velocity of the existing monetary base increases.
What is really cool is that bitcoin separates the issue of storage from the issue of earning a return on idle money. These were tied together before, even when gold was around: In fact fractional reserve banking arose from the fact that the goldsmiths (who were tasked with storing other people's gold) realized they could issue more depository notes than they actually had gold for.
So now that there is no need for people to deposit at banks unless they want to earn an extra return, we may see a lower level of demand for bank services. Maybe.

    BUT... the moment the bank suffered a loss or a borrower stopped paying interest, *everybody* would know and a run would surely start within moments.

Banks always lend a sizeable chunk of their own money alongside depositors. As long as that buffer isn't running out, there's not rational reason for a depositor to worry. It would take a lot of losses to trigger a bank run (like we saw in 2008). Knowing the exact amount held by a bank would also protect against bank runs being started on just a rumour, and it would encourage banks to keep and prove they have a large reserve, so that the depositors are reassured.
Also nothing stops the existence of a "lender of last resort". The difference is that unlike the Fed, it can't just print on demand, so it'd have to hold large amounts of cash to be sent to a distressed bank at a moment's notice. That would be pretty expensive.

[suryc]

This might be a little off topic, but there's this Financial Times article today about the talk of "BitBonds"...
http://www.ft.com/cms/s/0/e9198f38-b7cb-11e2-9f1a-00144feabdc0.html#axzz2VhnrjxvE

[gendal]

    BUT... the moment the bank suffered a loss or a borrower stopped paying interest, *everybody* would know and a run would surely start within moments.

Banks always lend a sizeable chunk of their own money alongside depositors. As long as that buffer isn't running out, there's not rational reason for a depositor to worry. It would take a lot of losses to trigger a bank run (like we saw in 2008). Knowing the exact amount held by a bank would also protect against bank runs being started on just a rumour, and it would encourage banks to keep and prove they have a large reserve, so that the depositors are reassured.

Agree that false rumours would be harder to spread and I also agree transparency would lead to greater conservatism.   

However, it would be fascinating to see how things played out in the real world.  For example, banks today only need to publish their accounts periodically (e.g. quarterly) and go to great lengths to make them look good (e.g. the Lehman Repo 105 transactions, the tendency of companies to discount heavily towards the end of a period to get signings, etc, etc).

In between reporting periods, I suspect the numbers jump all over the place....  and the same would be true here....  even if a "Bitcoin bank" were very well run, well capitalised and had lots of liquidity, there would be periods where  good borrowers were a bit late and some depositors had drawn out more than expected - and a snapshot at that time would make it look like it was about to collapse. 

Perhaps the solution would be even greater transparency - e.g. the successful banks would also make their internal models and cash-flow forecasts public - and reconciled against the blockchain.   One thing's for certain, I don't think a bank based on obfuscation/secrecy would stand a chance.

Also nothing stops the existence of a "lender of last resort". The difference is that unlike the Fed, it can't just print on demand, so it'd have to hold large amounts of cash to be sent to a distressed bank at a moment's notice. That would be pretty expensive.

Agreed.  So, in many ways, it would be similar to the gold standard days (e.g. the JP Morgan stories from the 1907 panic, etc).

And I guess you could be sure there would never be anything as scary as this  http://soberlook.com/2013/06/how-did-we-get-here-map-feds-balance.html

[halfawake]

I didn't vote in the poll because there wasn't an option for "Yes, but with very different results than in the fiat world".  As far as countryfree's comment that you could still get a mortage with bitcoin banks - yes, this is probably true.  But forget about the 3% interest rates that you're seeing today (at least in the states), or even 5%.  It'd probably be at least 15%. 

Would credit be possible with bitcoin?  Yes, but it'd be more difficult, and therefore likely much more expensive in terms of interest rates.

[johnyj]

I think bitcoin will co-exist with fiat, and as long as fiat exists, the motivation to borrow bitcoin is very low, since it's always preferred to borrow a inflative fiat currency

The only reasonable consideration is borrowing a lot of bitcoin and sell them, causing the price to crash, and buy them back to profit in the process, but shorting has unlimited risk

[bitcoinbear]

I didn't vote in the poll because there wasn't an option for "Yes, but with very different results than in the fiat world".  As far as countryfree's comment that you could still get a mortage with bitcoin banks - yes, this is probably true.  But forget about the 3% interest rates that you're seeing today (at least in the states), or even 5%.  It'd probably be at least 15%. 

Would credit be possible with bitcoin?  Yes, but it'd be more difficult, and therefore likely much more expensive in terms of interest rates.

But why would it be more expensive? Bitcoin's nature is deflationary (after the initial inflation period), so it would make sense for bitcoin denominated interest rates to be lower than fiat rates, because the interest rate does not have to overcome the inflation rate.

[gendal]

I didn't vote in the poll because there wasn't an option for "Yes, but with very different results than in the fiat world".  As far as countryfree's comment that you could still get a mortage with bitcoin banks - yes, this is probably true.  But forget about the 3% interest rates that you're seeing today (at least in the states), or even 5%.  It'd probably be at least 15%. 

Would credit be possible with bitcoin?  Yes, but it'd be more difficult, and therefore likely much more expensive in terms of interest rates.

But why would it be more expensive? Bitcoin's nature is deflationary (after the initial inflation period), so it would make sense for bitcoin denominated interest rates to be lower than fiat rates, because the interest rate does not have to overcome the inflation rate.

Quite - and I think this will be the problem for a bank that issues bitcoin-denominated liabilities (i.e. takes bitcoin deposits).

Recall: the purpose of a bank is to perform maturity transformation:  it issues short-dated liabilities in order to fund positions in longer-dated, higher-yielding assets.   The spread funds the bank's operations, covers losses and provides a source of profit.  This makes banks inherently unstable and vulnerable to runs, which is a problem in and of itself in a world without a lender-of-last-resort that can print currency on demand to lend to solvent (but illiquid) institutions.

However, the bigger problem to my mind is that this model implies an institution that issues bitcoin-denominated liabilities must invest in assets that yield more than the yield they are promising their bitcoin depositors.

Now, if bitcoin's deflationary nature kicks in and the purchasing power of a bitcoin increases over time, the real challenge for the bank is to find suitable assets in which to invest.

If the only suitable assets provide a (real) yield of, say, 5%, it is entirely likely a bitcoin bank would have to offer nominal interest rates to depositors that are negative.

That can still be desirable in a fiat world since large holders of currency may not want to take responsbility for the safekeeping of physical cash (nominal yield 0%) and so would be content to accept a small negative nominal yield... but all Bitcoin users have the ability to manage their own wallets, at least in principle.

So... it's hard to see how someone could build a viable business model based on paying interest on deposits...

[weisoq]

I didn't vote in the poll because there wasn't an option for "Yes, but with very different results than in the fiat world".  As far as countryfree's comment that you could still get a mortage with bitcoin banks - yes, this is probably true.  But forget about the 3% interest rates that you're seeing today (at least in the states), or even 5%.  It'd probably be at least 15%. 

Would credit be possible with bitcoin?  Yes, but it'd be more difficult, and therefore likely much more expensive in terms of interest rates.

But why would it be more expensive? Bitcoin's nature is deflationary (after the initial inflation period), so it would make sense for bitcoin denominated interest rates to be lower than fiat rates, because the interest rate does not have to overcome the inflation rate.

a deflationary nature implies a high real rate of interest

[bitcoinbear]

I didn't vote in the poll because there wasn't an option for "Yes, but with very different results than in the fiat world".  As far as countryfree's comment that you could still get a mortage with bitcoin banks - yes, this is probably true.  But forget about the 3% interest rates that you're seeing today (at least in the states), or even 5%.  It'd probably be at least 15%. 

Would credit be possible with bitcoin?  Yes, but it'd be more difficult, and therefore likely much more expensive in terms of interest rates.

But why would it be more expensive? Bitcoin's nature is deflationary (after the initial inflation period), so it would make sense for bitcoin denominated interest rates to be lower than fiat rates, because the interest rate does not have to overcome the inflation rate.

a deflationary nature implies a high real rate of interest

Depends on how strong the deflation is. If we are deflating at 1%, then anything with a real rate of return over 1% will still give a positive nominal return rate.

Contrast this to inflating currencies: If you are only inflating at 1%, then something with a real loss of 0.5% will still give a positive nominal return rate.