Inflation, Fractional Reserve, and Bitcoins

[InterArmaEnimSil]

I've seen a few claims, on these forums and elsewhere, that bitcoins, because they are limited in supply, are free from inflation, and once or twice I've seen claims that this set supply would eliminate fractional reserve bank policies.  Would anyone care to explain this to me? 

The way I see it, the supply of bitcoins is limited, yes, but its akin to the supply of, in the US, physical one-dollar bills.  The majority of the US economy, however, is not cash - it is credit, or dollars on account, both of which are backed essentially by loan collateral.  This collateral forms the basis for more loans than it is actually worth, and thus we have fractional reserve banking.  The limited supply of bitcoins will stand at 21,000,000 maximum.  However, this in no way prevents people from establishing accounts with bitcoin-equivalent units in them that do not actually exist - exactly as credit and savings accounts are done today.  These pseudo-BTC would be traded, just as loan-based pseudo-dollars are traded today, and there is no limit to their number, nor any protection against fractional reserve policies.  Am I going wrong here somewhere?  I certainly hope so, because if not....then I really don't see the advantage of BTC at all.

[Gavin Andresen]

That's right.

One of Bitcoin's big advantages is that you can be your own bank; you don't have to trust a government-backed fractional reserve bank to keep your extra cash safe.

If you WANT to trust a fractional-reserve Bitcoin Bank, feel free.  But don't go crying to your congressman if you lose all your money, please.

[sirius]

Bitcoin makes a difference between storing money and lending money. If you want to store your money, you just make a backup of your wallet, possibly encrypted, to a safe place. It's clearly distinguishable from giving the control of your money to an investment bank which lends them for interest. In the mainstream bank system it's different: you deposit 1000$, the bank lends 900$ of it to someone but still shows 1000$ as your balance, and so the money supply is inflated.

[dwdollar]

Also...  Any Bitcoin bank will have to rely heavily on it's reputation.  They might be able to practice fractional reserve banking, if they offer promises for Bitcoins.  BUT, they won't have nannies to print more money for them when they overextend themselves either through fraud or carelessness.  Then it's bye, bye.  I don't see the Bitcoin economy being completely dependent on fractional reserve banking.

[Bitcoiner]

I've seen a few claims, on these forums and elsewhere, that bitcoins, because they are limited in supply, are free from inflation, and once or twice I've seen claims that this set supply would eliminate fractional reserve bank policies.  Would anyone care to explain this to me? 

The way I see it, the supply of bitcoins is limited, yes, but its akin to the supply of, in the US, physical one-dollar bills.  The majority of the US economy, however, is not cash - it is credit, or dollars on account, both of which are backed essentially by loan collateral.  This collateral forms the basis for more loans than it is actually worth, and thus we have fractional reserve banking.  The limited supply of bitcoins will stand at 21,000,000 maximum.  However, this in no way prevents people from establishing accounts with bitcoin-equivalent units in them that do not actually exist - exactly as credit and savings accounts are done today.  These pseudo-BTC would be traded, just as loan-based pseudo-dollars are traded today, and there is no limit to their number, nor any protection against fractional reserve policies.  Am I going wrong here somewhere?  I certainly hope so, because if not....then I really don't see the advantage of BTC at all.

Fractional reserve banking is unstable without a monopoly over the ability to print currency, due to the >0 possibility that a bank runs out of reserves. The way banking in BTC will likely work is that you will have On-demand deposits, and time-deposits.

On-demand deposits will be stored at the bank, and will not be lent out. You will likely pay a small fee for this service.

Time deposits will be lent out, but cannot be withdrawn at anytime. You will also have to accept the possibility of loss.

The Mises Forums offers a lot of info about fractional reserve banking; I would recommend reading there for more info on how it would work in a free market without a central authority (like Bitcoin).

[Gavin Andresen]

Fractional reserve banking is unstable without a monopoly over the ability to print currency, due to the >0 possibility that a bank runs out of reserves.

That's like saying: "Gold atoms are unstable because quantum mechanics tells us that there is a >0 possibility that they will spontaneously decay."

Yes, in the very very very long run the universe will suffer heat death and there will be no gold (or any other atoms) left.

If the probability of bank runs is very small, then fractional reserve banking works.  Or, in other words, if banks can establish and maintain trust in their ability to repay deposits they'll be stable even if they practice fractional reserve banking.

I hope we'll eventually find out the hard way if, or which, Bitcoin banks can establish and maintain trust.

[sirius]

On-demand deposits will be stored at the bank, and will not be lent out. You will likely pay a small fee for this service.

In this case the bank might just store your encrypted wallet to ensure you that your money won't be lent out. Or you could just maintain the backup yourself without a bank.

[Bitcoiner]

Fractional reserve banking is unstable without a monopoly over the ability to print currency, due to the >0 possibility that a bank runs out of reserves.

That's like saying: "Gold atoms are unstable because quantum mechanics tells us that there is a >0 possibility that they will spontaneously decay."

Yes, in the very very very long run the universe will suffer heat death and there will be no gold (or any other atoms) left.

If the probability of bank runs is very small, then fractional reserve banking works.  Or, in other words, if banks can establish and maintain trust in their ability to repay deposits they'll be stable even if they practice fractional reserve banking.

I hope we'll eventually find out the hard way if, or which, Bitcoin banks can establish and maintain trust.

Not true. If I deposit 100 bitcoins at a bank, the bank lends out 90, and I want to withdraw my 100 bitcoins, the bank is screwed. Even if they lend out 25, the bank is screwed.

On demand deposits simply cannot be loaned out if a banking system is to ultimately remain stable. Sure, some banks can try to do it, but then they better not call them "on demand deposits". Deposits can be loaned out, but not with a guarantee of redemption. That is simply impossible as Bitcoins cannot be created out of thin air.

So long as on-demand deposits are not loaned out and time deposits are loaned out, we're fine. Alternatively, on-demand deposits can be loaned out, with a "maybe" promise of repayment. Try and see who will go for that You might call this fractional reserve banking, but then we're just arguing over semantics.

[Bitcoiner]

On-demand deposits will be stored at the bank, and will not be lent out. You will likely pay a small fee for this service.

In this case the bank might just store your encrypted wallet to ensure you that your money won't be lent out. Or you could just maintain the backup yourself without a bank.

Yep, but then you couldn't take advantage of remote checking services unless you provided the password to decrypt the wallet. But that's no different than just giving them the coins.

I fully expect that both types of services will exist.

[InterArmaEnimSil]

I think everyone is missing my point.  Yes, if the economy operates on bitcoin transactions, banks are screwed, etc.  However, consider the following example:

1) I deposit BTC1000 in a bank.  They offer me 2%/yr interest.  They also issue me a checkbook and a debit card.

2) The bank immediately loans out BTC900 of my BTC1000.  My balance "stays" at BTC1000.  This is the creation of BTC900 new.  No new bitcoins were really created - that would require the use of computing power.  Rather, the bank is merely lying to me, telling me that the BTC1000 are mine, and telling someone else that BTC900 of those same bitcoins are theirs.  Thus, although no new bitcoins have actually been created, as far as the economy is concerned there are now BTC1900 in circulation, where before there were only BTC1000.  Inflation.  This, and not by the printing presses, is how dollar, pound, euro, yen, and rupee inflation occur too - merely by bank lies, not by the printing of bills.

3) Assume there are thousands of other people who have deposits on the bank, each with checkbooks and debit cards.  This works equally well if you want thousands of people with deposits in *any* bank, as the banking system as a whole simulates a single, enormous, monolithic bank.

4)Now, if a bunch of people want to go and withdraw their BTC to make purchases, then yes, the banks are screwed, because they have lied, and say that there are more BTC on deposit than there actually are.  However, using BTC to make purchases is *so difficult!*  You have to know an *address,* and run a *client,* and have an *internet connection....*  (A bit of sarcasm there...)....so people decide they're just going to use their debit cards instead. 

5) So, "Bob" buys BTC35 worth of groceries from "FoodMart."  The bank executes "BobAccount-BobAccount-35; FoodMartAccount=FoodMartAccount+35;"  No bitcoins actually change hands.  If Bob and FoodMart use different banks, then maybe some actual coins change hands, but only the difference between the number in the day that flowed from Bank A to Bank B, minus those that flowed from Bank B to Bank A, not the full amount.

6)Thus, as long as a decent percentage of the populace uses bank accounts of any kind, then the fractional reserve, inflationary system remains in place.  This is because although your money is *denominated* in bitcoins, the real money is bank account balances, which have none of the restrictions which bitcoins have.

The one saving grace which I can see is that if it were public knowledge precisely how many bitcoins exist, then people wouldn't be fooled by the bank balances - they would look at their balance and go "There's no way I have that percentage of the bitcoins in the world."  But this is assuming no governmental or business interests interfere with this, and its pretty optimistic about the logical reasoning skills of people in general.

A few responses to the earlier points...

One of Bitcoin's big advantages is that you can be your own bank; you don't have to trust a government-backed fractional reserve bank to keep your extra cash safe.
If you WANT to trust a fractional-reserve Bitcoin Bank, feel free.  But don't go crying to your congressman if you lose all your money, please.

You can be your own bank now - you can bury cash in your back yard or keep your entire net worth in dollar bills in a safe in your house.  Banks, however, offer something to entice the users to trust them.  If they offered interest in Bitcoins, people would trust them, just as they trust them when they offer interest in dollars.

Bitcoin makes a difference between storing money and lending money. If you want to store your money, you just make a backup of your wallet, possibly encrypted, to a safe place. It's clearly distinguishable from giving the control of your money to an investment bank which lends them for interest. In the mainstream bank system it's different: you deposit 1000$, the bank lends 900$ of it to someone but still shows 1000$ as your balance, and so the money supply is inflated.

No, this is no different from the current system.  If you want to store your money, you put your wallet in a safe in your house.  This is clearly distinguishable from giving the control of your money to an investment bank which lends them for interest.  In the bitcoin bank system, you deposit BTC1000, the bank lends out BTC900, but when you ask the bank, they still tell you BTC1000 is in your account, and so the money supply is inflated.

Also...  Any Bitcoin bank will have to rely heavily on it's reputation.  They might be able to practice fractional reserve banking, if they offer promises for Bitcoins.  BUT, they won't have nannies to print more money for them when they overextend themselves either through fraud or carelessness.  Then it's bye, bye.  I don't see the Bitcoin economy being completely dependent on fractional reserve banking.

Really?  They can "print" money by moving fake balances into their accounts.  This is impossible for now, as doing so would probably make the number of BTC in circulation exceed 21M.  However, in a while, when natural deflation sets in, and a loaf of bread is .000001BTC, there's plenty of room for banks to fictitiously expand back up to the 21M limit.

Fractional reserve banking is unstable without a monopoly over the ability to print currency, due to the >0 possibility that a bank runs out of reserves.

Yes, but you're mistaking "print" currency on a printing press for "create" money in accounts.  Banks could still do this with bitcoins.  They wouldn't create real bitcoins, but it would certainly seem real to the population, inflating the currency.

The way banking in BTC will likely work is that you will have On-demand deposits, and time-deposits.
On-demand deposits will be stored at the bank, and will not be lent out. You will likely pay a small fee for this service.

Time deposits will be lent out, but cannot be withdrawn at anytime. You will also have to accept the possibility of loss.

There is no way at all that we can project what banking under bitcoins might look like.  That would depend on A) what is legal in a particular location, and B) What people can get away with.  The bitcoin itself does not control, or influence in any way, the nature of banking.

In this case the bank might just store your encrypted wallet to ensure you that your money won't be lent out. Or you could just maintain the backup yourself without a bank.

Banks don't store wallets, just as banks don't store dollar bills now.  They keep a cache or currency on hand based upon what they expect to need, and the rest is lent out.  It would work identically with bitcoins - what people care about is their "balance" - how much the bank *tells* them they have, regardless of how much is there.  This difference between reserve_cash and total_balances_sum is the inflation.  Banks lie to people about how many dollars they have, and they would lie identically about bitcoins, and people would remain ignorant, perhaps willfully, thanks to the promise of interest.  Transactions, by and large, are made on bank balances now, not on dollars, and would be made on bank balances then, not on bitcoins.

Not true. If I deposit 100 bitcoins at a bank, the bank lends out 90, and I want to withdraw my 100 bitcoins, the bank is screwed. Even if they lend out 25, the bank is screwed.

That's not true.  If a bank does a statistical analysis of the number of bitcoins needed in a day/week/month, etc, and can predict the number with very high accuracy, then if they keep that many coins on hand, they can satisfy depositors.  This has kept the banks in place since the middle ages - the ONLY time it failed was in the Great Depression.  The current crises is due to overextension, yes, but not so much that it created a shortage of cash.  Keep in mind that banks keep on hand enough money  such that they can satisfy all of your requests, and all of your neighbors, and all of the requests of, say, a thousand people.  They may have a million customers, though, which means they've lent out 99% of their money.  Unless, though, they get 1,001 customers in a day, they're completely safe - and they may know they won't get that many customers simply because there isn't enough time in business hours to process them all.

On demand deposits simply cannot be loaned out if a banking system is to ultimately remain stable. Sure, some banks can try to do it, but then they better not call them "on demand deposits". Deposits can be loaned out, but not with a guarantee of redemption. That is simply impossible as Bitcoins cannot be created out of thin air.

Yes, sadly, bitcoins can be created out of thin air.  More accurately, the perception of bitcoins can be created out of thin air.  People don't care how many dollars are in their wallet.  They care how many dollars are in their wallet, plus how many dollars the bank *tells* them are in their checking account.  If they buy things using the checking account, and the money goes to another account, then no money is even needed!  Simply, bank A subtracts a number from an acocunt, and bank B adds it in.  Similarly, you could tell people they had BTC1000, and if they never want *all* those BTC1000 in coin form, then they never know you don't have them.  You create the coins out of thin air by lying about the balance, not by minting them.  And, of course, you give interest, which tells Joe Schmoe "Leave your money in the bank.  Don't take it all out, because then you make less money!"  This works...it creates dollars out of thin air without a printing press, and it would create bitcoins out of thin air without the crypto algorithm.

Yep, but then you couldn't take advantage of remote checking services unless you provided the password to decrypt the wallet. But that's no different than just giving them the coins.

Nope, you could use remote checking by just using your bank balance.  Not bitcoins need be involved.  People just need to believe that bitcoins are involved.  The only time you need bitcoins is if someone makes a withdraw to cash, not a withdraw to any other account.


The central mistake in all of this is that people are assuming that if the money is expressed in bitcoins, then bitcoins are being used.  However, bank balances, not dollars, are used for most transactions today, making it possible for the banks to lie and essentially print money.  I welcome further forum debate on the issue.  For a humorous explanation of how banks, not governments with printing presses, print money today, just as they would create money with bitcoins, see the two online films "Money as Debt" and "Money as Debt 2: Promises Unleashed."  They're not entirely accurate, and they drastically oversimplify the issue, but they dispel the common myth that governments, not banks, create money supply.

[db]

InterArmaEnimSil, you are basically right. It's a bit frustrating that many people here keep thinking that banks won't be able to use bitcoins like any other currency.

However, some things are worth noting. There is nothing intrinsically special about banks. If I borrow 1000฿ each from my pals Alice and Bob and promise to pay them back anytime they want then together we will consider ourselves to have more than 2000฿. That's exactly the same kind of inflation. And it's no big deal. It's no big deal because it quickly stabilizes and then there is no more inflation. The only way to have ongoing inflation is to increase the base money supply and Bitcoin prevents that.

The problem with many banks today is not fractional reserves. The problem is that their risks are guaranteed by governments. So they take huge risks and enjoy greats profits while it lasts. When it blows up taxpayers pay. To make it worse governments often pay with "free" freshly printed money. Again Bitcoin fixes the money printing issue but not the guarantee issue (or maybe a little if it makes it harder to collect taxes).

Really?  They can "print" money by moving fake balances into their accounts.  This is impossible for now, as doing so would probably make the number of BTC in circulation exceed 21M.  However, in a while, when natural deflation sets in, and a loaf of bread is .000001BTC, there's plenty of room for banks to fictitiously expand back up to the 21M limit.

This sounds confused. In a bank run their problem is that they don't have enough real bitcoins and they can't create real bitcoins. What does the 21M limit have to do with anything?

[Bitcoiner]

I think everyone is missing my point.  Yes, if the economy operates on bitcoin transactions, banks are screwed, etc.  However, consider the following example:

1) I deposit BTC1000 in a bank.  They offer me 2%/yr interest.  They also issue me a checkbook and a debit card.

Is this a time deposit or an on-demand deposit? I do not see interest being paid on on-demand deposits. That could imply that the bank is using that money and that it's not really there.

2) The bank immediately loans out BTC900 of my BTC1000.  My balance "stays" at BTC1000.  This is the creation of BTC900 new.  No new bitcoins were really created - that would require the use of computing power.  Rather, the bank is merely lying to me, telling me that the BTC1000 are mine, and telling someone else that BTC900 of those same bitcoins are theirs.  Thus, although no new bitcoins have actually been created, as far as the economy is concerned there are now BTC1900 in circulation, where before there were only BTC1000.  Inflation.  This, and not by the printing presses, is how dollar, pound, euro, yen, and rupee inflation occur too - merely by bank lies, not by the printing of bills.

Agreed, the bank is lying to you. I hope it is clear to everyone why this is unstable, and can even be considered fraud. If the bank tells you that the deposit is on demand and always available, then it better always be available. If it's not, that's a contractual failure and fraud.

If your money is used to buy a bond, on the other hand, this isn't fraud. You know that the borrower can default and that there is risk, and you know where your money really is (it's with the borrower, not the bank). No lying.

6)Thus, as long as a decent percentage of the populace uses bank accounts of any kind, then the fractional reserve, inflationary system remains in place.  This is because although your money is *denominated* in bitcoins, the real money is bank account balances, which have none of the restrictions which bitcoins have.

The one saving grace which I can see is that if it were public knowledge precisely how many bitcoins exist, then people wouldn't be fooled by the bank balances - they would look at their balance and go "There's no way I have that percentage of the bitcoins in the world."  But this is assuming no governmental or business interests interfere with this, and its pretty optimistic about the logical reasoning skills of people in general.

Fractional reserve is OK so long as the banks aren't blatantly lying about what they're doing. Without a government ready to print additional bitcoins to bail out banks, you can bet that they will be more careful about what they're doing, since if they get caught in the lie, they're fvcked.

A few responses to the earlier points...

Fractional reserve banking is unstable without a monopoly over the ability to print currency, due to the >0 possibility that a bank runs out of reserves.

Yes, but you're mistaking "print" currency on a printing press for "create" money in accounts.  Banks could still do this with bitcoins.  They wouldn't create real bitcoins, but it would certainly seem real to the population, inflating the currency.

I understand what you mean, but what I mean is that there will be no backstop called the Federal Reserve to bail out the banks when they go bust, and trust me, the greedy ones WILL go bust.

The way banking in BTC will likely work is that you will have On-demand deposits, and time-deposits.
On-demand deposits will be stored at the bank, and will not be lent out. You will likely pay a small fee for this service.

Time deposits will be lent out, but cannot be withdrawn at anytime. You will also have to accept the possibility of loss.

There is no way at all that we can project what banking under bitcoins might look like.  That would depend on A) what is legal in a particular location, and B) What people can get away with.  The bitcoin itself does not control, or influence in any way, the nature of banking.

Yes, I agree with you here. However, I would demand honesty from the banks. I can surmise others can do the same. We can never be entirely sure what's going on; the banks could lie, they could be running a pyramid scheme; what we DO know is that honesty is in everyone's best interests, because there is no Federal Reserve to just paper over the losses when the shit hits the fan. I cannot surmise HOW this will be, but I do know that it will be in everyone's interests to see that it is done.

Not true. If I deposit 100 bitcoins at a bank, the bank lends out 90, and I want to withdraw my 100 bitcoins, the bank is screwed. Even if they lend out 25, the bank is screwed.

That's not true.  If a bank does a statistical analysis of the number of bitcoins needed in a day/week/month, etc, and can predict the number with very high accuracy, then if they keep that many coins on hand, they can satisfy depositors.  This has kept the banks in place since the middle ages - the ONLY time it failed was in the Great Depression.  The current crises is due to overextension, yes, but not so much that it created a shortage of cash.  Keep in mind that banks keep on hand enough money  such that they can satisfy all of your requests, and all of your neighbors, and all of the requests of, say, a thousand people.  They may have a million customers, though, which means they've lent out 99% of their money.  Unless, though, they get 1,001 customers in a day, they're completely safe - and they may know they won't get that many customers simply because there isn't enough time in business hours to process them all.

You're forgetting that Bitcoins are not an inflationary regime. It will be much more difficult to keep the correct number of Bitcoins on hand when you can't just print them willy nilly. A bank might be able to find an optimal number, and again, there's nothing wrong with this. I just think that for the banking system to be honest, they need to fess up and seperate time deposits from on demand deposits. If people want to go with riskier banks that do fractional reserve with the on demand deposit, that's their business. If it takes a few busts to scare people off from that, then so be it

I essentially agree with everything you say, but I see the dynamics as being different because there's no Big Daddy to bail the kids out from their mistakes when they mess up, yet again

[InterArmaEnimSil]

However, some things are worth noting. There is nothing intrinsically special about banks.

At least in the US, what's special about a bank (National Association Organization, ie, Chase Manahattan Bank, N.A.), is that it has a charter to literally create money by lending out more than it has on reserve and demanding the full sum in repayment, ie, fractional reserve practices.  

If I borrow 1000฿ each from my pals Alice and Bob and promise to pay them back anytime they want then together we will consider ourselves to have more than 2000฿. That's exactly the same kind of inflation. And it's no big deal. It's no big deal because it quickly stabilizes and then there is no more inflation. The only way to have ongoing inflation is to increase the base money supply and Bitcoin prevents that.

This is not quite the same thing.  I agree the two situations are deceptively similar, but here is where they differ.

Borrowing Example:

Alice has 1000BTC.  Bill has 1000BTC.  Christina needs 2000BTC, so she borrows 1000 from Bill and 1000 from Alice.  Alice loses 1000, Bill loses 1000, and Christina gains 2000.  Total in play before transaction: 2000.  Total after transaction: 2000

Bank example:

BigBank has 3000 Bitcoins, but no one knows this except the BigBank CEO.  They have a fancy office, though, so everyone assumes they have millions of bitcoins.  Christina needs 2000 Bitcoins, so she goes to BigBank.  Christina signs a pledge to return 2,100 bitcoins at this date next year (5% interest), and BigBank opens an two "accounts" for Christina.  These accounts are nothing more than two lines on spreadsheets.  The first:
Christina - Line of Credit - -2000BTC
The second:
Christina - Checking: 2000 BTC.

Before the transaction, BigBank had 3000 Bitcoins, and Christina had 0 Bitcoins, for a total of BTC3000.  After, BigBank has 3000Bitcoins (they haven't actually given Christina any cryptographically-signed data - they just typed two numbers in a spreadsheet), and Christina "has" BTC2000.  Now, if Christina demanded the BTC2000 in cash, BigBank would have to turn it over, but she's not going to do that.  She's going to take the debit card that she got for her new checking account and leave. (Even if she doesn't do that in this instance, on average, most people will, because money in an account earns interest, so it "costs" them money to request it in cash.  Also, maybe the debit card is easier to handle, etc.  The entire fractional reserve system is based on the correct assumption that people will not demand cash an overwhelming percentage of the time).

Total Available to be Spent Before Transaction: 3000BTC (3000 BigBank + 0 Christina)
Total Available After Transaction: 500BTC (3000 BigBank + 2000 Christina).

The two thousand bitcoins that Christina got didn't exist before the transaction.  They were created out of thin air.  Of course, they really weren't minted.  BigBank didn't hash them using a client, so in fact don't exist.  But, through the "miracle" of fractional reserve banking, the following happens.

Christina goes to Dirty Dan's Dirtbike Dealership.  Dirty Dan happens to except Bit-Visa.  So, Christina swipes her debit card, and BigBank moves the 2000BTC number (which is in fact 0 real bitcoins) from her checking account into Dirty Dan's checking account.  These 2000BTC don't exist, as we established above, but nonetheless, Christina just bought a Dirty Dan Dirtbike because both she and Dirty Dan both *think* they exist.

Later, a year rolls around, and Christina has to work two jobs to pay back the 2,100BTC she owes BigBank.  What did those 2,100BTC cost BigBank?  Nothing.  They never even existed.  Probably, they don't exist now, because Christina's employer, Ernie's Elastics, has an account with BigBank...and he took out a loan with BigBank to cover business expenses, and so her salary is made of bitcoins that don't exist...and on and on and on....

Even though the 2000 BC don't exist, the *purchasing power* of 2,000BTC has just entered the economy.  This is the inflation that is problematic.

Thus, in the borrowing example, Alice and Bob lose money and Christina gets it.  In the BigBank example, no one loses money, but everyone trusts BigBank, and so their pledge that Christina has 2,000BTC to spend is just as good as those 2,000BTC, even though their pledge is a lie, and those bitcoins do not exist.

That is the situation which causes inflation, and it is in no way related to the underlying supply of pieces of paper that make dollar bills, or hashed kilobytes that make real bitcoins.  Its all, quite literally, imaginary.  Thus, Bitcoin is subject to the same inflationary pressures as dollars, euros, or pounds.

The problem with many banks today is not fractional reserves. The problem is that their risks are guaranteed by governments. So they take huge risks and enjoy greats profits while it lasts. When it blows up taxpayers pay. To make it worse governments often pay with "free" freshly printed money. Again Bitcoin fixes the money printing issue but not the guarantee issue (or maybe a little if it makes it harder to collect taxes).

Governments do not pay with "freshly printed money."  The money isn't printed, nor does it go through the government at all.  The Federal Reserve, which is a private bank just like Chase or Wells Fargo or HSBC, merely writes an "account" for the troubled bank, and money pops magically into existence just like the example above.  The government only has to print enough money to keep the banks from running out of *what the people ask for in cash*, which, in today's world of credit cards, PayPal, etc, is a very, very small fraction of the total money created.  The rest of the money is blessed into existence whenever a loan is made, because to loan out five dollars of five trillion dollars, the loaning bank loses precisely zero dollars.  The same is true with bitcoins - the accounts are fictitious numbers, and in no way represent the number of bitcoins, or dollars, or whatever else, that physically (or electronically) exist.

This sounds confused. In a bank run their problem is that they don't have enough real bitcoins and they can't create real bitcoins. What does the 21M limit have to do with anything?

The problem is not a bank run - the problem is inflation.  Why would people demand real bitcoins?  Why would they not just use their account balances.  Heck, a website for a bank account could look *exactly* like the Bitcoin client, and users wouldn't know the difference.  A run on the bank only occurs when people demand real currency (dollar bills, bitcoins, whatever).  However, most of the time, even with paper money, people are willing to trust their bank balances and don't demand cold hard cash.  If cold hard cash looked and felt and seemed exactly like the bank balances to most people (which they do with bitcoin - one computer screen or another, no one who's not a programmer knows the difference), then people, as with today, would not demand real bitcoins.  They can tell the difference between a bank balance and a dollar bill, but as far as they know, real bitcoins and bank balances are *exactly* the same thing.  So, a run on the bank is even *less* likely than with paper currency.  In the meantime, inflation and a run on the bank are unrelated.

[InterArmaEnimSil]

Is this a time deposit or an on-demand deposit? I do not see interest being paid on on-demand deposits. That could imply that the bank is using that money and that it's not really there.

Scratch the interest then.  The bank IS using money that's not there.  That's the whole point.  They're using dollars that aren't there today, and tomorrow they're using bitcoins that aren't there.  That is the definition of fractional reserve lending.

Agreed, the bank is lying to you. I hope it is clear to everyone why this is unstable, and can even be considered fraud. If the bank tells you that the deposit is on demand and always available, then it better always be available. If it's not, that's a contractual failure and fraud.

No.  Under the US Code and the code of every other developed nation, then they are only committing fraud if the percentage of actually available accounts falls below some threshold.  For standard savings in the US, that ratio is now around 11%.  Which means that 89% of all accounts are at any given point *not redeemable.*  They are lying to you.  It is fraud.  Its just not *legally* fraud.  And no one is ever going to convince a solid 11% of all bank account holders to go demand cash at the same time, so they will never be caught.

Fractional reserve is OK so long as the banks aren't blatantly lying about what they're doing. Without a government ready to print additional bitcoins to bail out banks, you can bet that they will be more careful about what they're doing, since if they get caught in the lie, they're fvcked.

Fractional reserve is by definition the creation of liquidity (purchasing ability, or as I call them, "lie dollars") backed only by a borrower's promise to pay, not by actual currency.  This is, in your parlance, "blatantly lying about what they're doing."  I agree with you.  However, its legal with dollars and pounds and euros and it will be legal with bitcoins.  It SHOULD be illegal, but changing from dollars to bitcoins will not make it so.  

Also, you're correct that they're screwed if they're caught in the lie.  That's a run on the bank, and is a heck of a lot worse than even our current financial mess.  It causes everyone to open their eyes, go "the banks are lying to us!" and hide their money in their mattress for the next hundred years.  There are senior citizens today who don't have bank accounts because they were rudely awoken to the bank's fraudulent but legal system in the thirties, while the rest of us have the wool over our eyes.

I understand what you mean, but what I mean is that there will be no backstop called the Federal Reserve to bail out the banks when they go bust, and trust me, the greedy ones WILL go bust.

I wish this were the case.  However, why would their be no Federal Reserve?  The Federal Reserve is independent of the US Bureau of Engraving and Printing - its just another bank.  Nothing stops a nation from creating such a bank with bitcoins.  They don't have to print bitcoins, they just have to engage in fractional reserve and seem big and strong and legit enough that no one will ever question whether they have the money they claim to have.

However, I would demand honesty from the banks. I can surmise others can do the same. We can never be entirely sure what's going on; the banks could lie, they could be running a pyramid scheme; what we DO know is that honesty is in everyone's best interests...

Absolutely!  We should all demand honesty from the banks, and an end to the pyramid scheme that is going on.  However, my point is that shutting down the literal printing presses, which Bitcoin does when it gets to 21,000,000BTC, does not do this.

You're forgetting that Bitcoins are not an inflationary regime. It will be much more difficult to keep the correct number of Bitcoins on hand when you can't just print them willy nilly.

I think you're both right and wrong here.  Yes, it would be more difficult to keep a day's supply of bitcoins on hand when you couldn't request more cash.  However, I also believe that, under bitcoins, no one would *EVER*, or almost ever, request real bitcoins.  Today, people know the difference between a piece of paper with a picture on it and a number on a bank website.   Even though they don't understand the bank's fraud, they know there's something different about the electronic number and the paper.  Therefore, the bank must keep paper on hand, because people might demand it, believing it to be more secure than the bank number on the screen.  However, the distinction between bitcoins and bank balances is *much* more difficult to grasp.  If you're a computer scientist, if you've read the bitcoin whitepapers, etc, you know that there's a difference between a real bitcoin and a number on a bank account website.  The real bitcoin is cryptographically generated, and is not a lie.  Its even far more true in its value than the US paper money, which is what bitcoin is going for.  However, for 99.99% of the population, there is *no* difference between a bitcoin and a bank's fraudulent claim that bitcoins are in an account.  So, no one would ever (or would very rarely) demand bitcoins, making the number that the bank had to keep on-hand far more manageable, and in fact probably just a bit above 0.

I essentially agree with everything you say, but I see the dynamics as being different because there's no Big Daddy to bail the kids out from their mistakes when they mess up, yet again

I agree that the fact that bitcoins are separate from any government makes a difference.  Its a significant difference, and probably the biggest difference between bitcoins and dollars, pounds, euros, or whatever.  However, I think that fractional reserve bailouts could still happen, unfortunately, because people will not demand real bitcoins, not knowing the difference between a bitcoin and a bank balance.

[Bitcoiner]

I believe that we've reached the point in our discussion where we see what is, and we agree on what ought to be, and the direction where the market goes is really something that cannot be predicted ahead of time. I just want to say that there's a reason that the US government went off the gold standard, even though everything you say applies to gold as well: Real gold keeps its value (as will real Bitcoins), and people eventually catch on to the game.

I don't have time to reply to your post right now, since it's almost midnight , so I'll leave you with some interesting reading to peruse at your own leisure:

Here are three interesting threads that I found that you guys might be interested in:

A big one:
http://mises.org/Community/forums/t/6197.aspx

http://mises.org/Community/forums/p/17430/339679.aspx#339679
http://mises.org/Community/forums/p/8938/273181.aspx#273181

[db]

Thus, in the borrowing example, Alice and Bob lose money and Christina gets it.  In the BigBank example, no one loses money, but everyone trusts BigBank, and so their pledge that Christina has 2,000BTC to spend is just as good as those 2,000BTC, even though their pledge is a lie, and those bitcoins do not exist.

I routinely pay with friends' debts as currency.

"Hey, Bob owes me a hundred; when he pays he can pay for me too."
"Sure."

Businesses do similar things and without banks they would do it more. Sure, BigBank is more efficient at it but the effect is there.

That is the situation which causes inflation, and it is in no way related to the underlying supply of pieces of paper that make dollar bills, or hashed kilobytes that make real bitcoins.

So how come there has been no such inflation in gold in the hundreds of years it has been used as a currency in fractional reserve banking?

However, for 99.99% of the population, there is *no* difference between a bitcoin and a bank's fraudulent claim that bitcoins are in an account.  So, no one would ever (or would very rarely) demand bitcoins, making the number that the bank had to keep on-hand far more manageable, and in fact probably just a bit above 0.

There is one important difference. If bitcoins become widespread it will be more convenient and less costly to pay with bitcoins than with bank balances. That makes the demand for real bitcoins pretty high.

[InterArmaEnimSil]

So how come there has been no such inflation in gold in the hundreds of years it has been used as a currency in fractional reserve banking?

I see the issue now!  There's a disconnect between what we're discussing.  Let me try to be more clear.

Today's standard is fractional *in relation to the promises to pay that you (a bank) have on-hand, in deposit dollars.*  So, say you get five real dollars on hand, printed.  You then lend out fifty dollars because you have a 1/10 backing requirement.  Someone deposits those fifty dollars, and now you (the banking system, not necessarily the same company) have fifty-five dollars in backing!  Of course, you really only have the five dollars in paper money, but all that is required to make loans is that you have deposits, even if they're deposits of fictitious, un-backed money.  Now with fifty-five dollars on hand, you lend out another five hundred fifty dollars.  Someone deposits these into the banking system, and now five thousand five hundred dollars of loans can be made, and so on and so on, inflating the economy.  If you want to lend more, you just lend a little, then someone deposits that non-dollar-backed, fictitious debt money, that doesn't even exist in paper form, in *any* bank, then that bank can lend back even *more* money (than the money just fictitiously created) in loans.  Its all a cycle of fictitious dollars based on nothing but people's signatures on mortgage documents.  All you have to have on hand to back your loans are...loans.  Since you can make loans out of nothing, you can make all the loans you can imagine with no problem, with no backing.  All the while, you just need enough paper to cover a day's requests - not any percentage of the loans you actually make.

The gold standard was fractional in proportion to the number of pounds of gold you had on hand.  So, you could maybe lend out ten-gold-pounds worth of loans if you had one gold pound on-hand, but it stopped there.  There could be more money lent than gold on-hand because it was fractional, yes, but because it was based in gold and not debt, you couldn't just continue the cycle ad-infinitum.    Loans themselves could not form the basis of new loans.  In contrast, today, the basis of a new loan is nothing but another, older (sometimes only seconds older) loan.

Thus, I think I've found the disconnect between what I'm talking about and what everyone else on here is talking about.  I'm talking about fractional reserve banking where your reserve is just more debt - that's the current system.  You guys, I think, are talking about fractional reserve where the reserve is something solid - something that requires work to mine.  Bitcoins count for that. 

However, you're advocating going to the *bitcoin standard.*  Ie, if someone wants to make X-BTC in loans, they must have .10X-BTC in actual coins on-hand.

The forum and the central bitcoin website seem both to believe that converting to a bitcoin-denominated economy will create a bitcoin-standard economy.  This is not true.  Backing your money with bitcoins is a *huge* step beyond simply using bitcoins as the denominating money.

People can decide for themselves what currency to use, and I like bitcoins, and hope that the currency takes off, I really do.  However, even a bitcoin-denominated economy would still be a *debt-standard* economy.  Banks would see that people were using bitcoins, and they would go, "Ooh, we can make money offering services in bitcoins instead of dollars."  However, the law would remain that even though loans were made in amounts expressed in bitcoins, those loans had the backing of other loans, not actual bitcoins.

To get bitcoins used as currency, you just need adoption.  We're getting that, and that's great.  However, what do you need to eliminate the debt-standard and ensure that all loans created are *backed* with real bitcoins?

A government decree.  A law from Congress or Parliament that declared that loans had to be based in bitcoins, not debt.  GLHF.  Besides, even if we got that, it would eliminate inflation, but it would make bitcoins just another government-controlled, monopolized currency.  That would kill at least half of the point, right?

[Bitcoiner]

So how come there has been no such inflation in gold in the hundreds of years it has been used as a currency in fractional reserve banking?

I see the issue now!  There's a disconnect between what we're discussing.  Let me try to be more clear.

...

The gold standard was fractional in proportion to the number of pounds of gold you had on hand.  So, you could maybe lend out ten-gold-pounds worth of loans if you had one gold pound on-hand, but it stopped there.  There could be more money lent than gold on-hand because it was fractional, yes, but because it was based in gold and not debt, you couldn't just continue the cycle ad-infinitum.    Loans themselves could not form the basis of new loans.  In contrast, today, the basis of a new loan is nothing but another, older (sometimes only seconds older) loan.

People can decide for themselves what currency to use, and I like bitcoins, and hope that the currency takes off, I really do.  However, even a bitcoin-denominated economy would still be a *debt-standard* economy.  Banks would see that people were using bitcoins, and they would go, "Ooh, we can make money offering services in bitcoins instead of dollars."  However, the law would remain that even though loans were made in amounts expressed in bitcoins, those loans had the backing of other loans, not actual bitcoins.

To get bitcoins used as currency, you just need adoption.  We're getting that, and that's great.  However, what do you need to eliminate the debt-standard and ensure that all loans created are *backed* with real bitcoins?

A government decree.  A law from Congress or Parliament that declared that loans had to be based in bitcoins, not debt.  GLHF.  Besides, even if we got that, it would eliminate inflation, but it would make bitcoins just another government-controlled, monopolized currency.  That would kill at least half of the point, right?

Please read: http://en.wikipedia.org/wiki/Agorism

Your most important sentence: "However, the law would remain that even though loans were made in amounts expressed in bitcoins, those loans had the backing of other loans, not actual bitcoins."

There is no law when it comes to Bitcoins, other than the law of human action. Sovereign fiat might create new money with impunity, but then again, sovereign fiat is required to pay taxes and it is legal tender. Bitcoin shares none of these "advantages". Nobody will accept "loans upon loans upon loans" if they are not required to by force of law (and they defacto aren't; please read the Agorism post ), as the further this goes, the more unstable things get. I'll reply in more detail to your other post.

[Bitcoiner]

Is this a time deposit or an on-demand deposit? I do not see interest being paid on on-demand deposits. That could imply that the bank is using that money and that it's not really there.

Scratch the interest then.  The bank IS using money that's not there.  That's the whole point.  They're using dollars that aren't there today, and tomorrow they're using bitcoins that aren't there.  That is the definition of fractional reserve lending.

Except with Bitcoins, there is no force to keep people captive to a system that they know is ripping them off and no monetary pumping to paper over losses. No taxes, no legal tender laws. Anything operating in the Bitcoin economy survives (and fails) on its own merits alone.

Agreed, the bank is lying to you. I hope it is clear to everyone why this is unstable, and can even be considered fraud. If the bank tells you that the deposit is on demand and always available, then it better always be available. If it's not, that's a contractual failure and fraud.

No.  Under the US Code and the code of every other developed nation, then they are only committing fraud if the percentage of actually available accounts falls below some threshold.  For standard savings in the US, that ratio is now around 11%.  Which means that 89% of all accounts are at any given point *not redeemable.*  They are lying to you.  It is fraud.  Its just not *legally* fraud.  And no one is ever going to convince a solid 11% of all bank account holders to go demand cash at the same time, so they will never be caught.

So we both agree that the laws suck. However, these laws are just arbitrary points that have nothing to do with market forces and the banking system only survives because there is a lender of last resort. Such a lender of last resort cannot exist in a hard money system such as Bitcoin.

Fractional reserve is OK so long as the banks aren't blatantly lying about what they're doing. Without a government ready to print additional bitcoins to bail out banks, you can bet that they will be more careful about what they're doing, since if they get caught in the lie, they're fvcked.

Fractional reserve is by definition the creation of liquidity (purchasing ability, or as I call them, "lie dollars") backed only by a borrower's promise to pay, not by actual currency.  This is, in your parlance, "blatantly lying about what they're doing."  I agree with you.  However, its legal with dollars and pounds and euros and it will be legal with bitcoins.  It SHOULD be illegal, but changing from dollars to bitcoins will not make it so.  

Fraud should be illegal, yes. If a bank says "Hey, we only keep 10% of your money on hand, so it might not be there when you want it!", then it is no longer fraud, but good luck attracting depositors

Again, if it were not for legal tender rules and taxation, fiat currency would have a value of 0 with the kind of system we have in place today.

Also, you're correct that they're screwed if they're caught in the lie.  That's a run on the bank, and is a heck of a lot worse than even our current financial mess.  It causes everyone to open their eyes, go "the banks are lying to us!" and hide their money in their mattress for the next hundred years.  There are senior citizens today who don't have bank accounts because they were rudely awoken to the bank's fraudulent but legal system in the thirties, while the rest of us have the wool over our eyes.

Those senior citizens know something many people today don't, because they lived through it.

I understand what you mean, but what I mean is that there will be no backstop called the Federal Reserve to bail out the banks when they go bust, and trust me, the greedy ones WILL go bust.

I wish this were the case.  However, why would their be no Federal Reserve?  The Federal Reserve is independent of the US Bureau of Engraving and Printing - its just another bank.  Nothing stops a nation from creating such a bank with bitcoins.  They don't have to print bitcoins, they just have to engage in fractional reserve and seem big and strong and legit enough that no one will ever question whether they have the money they claim to have.

Don't like the word "private" fool you: The Federal Reserve as as much an arm of the government as is the Treasury, Congress, or anything else.

Why would nobody ever question them? Why would anyone even pay any attention to them? They can say they have 10 million Bitcoins, but who cares? There is a limit to the amount of lying that can go on. "You can fool some of the people all of the time, and all of the people some of the time, but you can not fool all of the people all of the time."

However, I would demand honesty from the banks. I can surmise others can do the same. We can never be entirely sure what's going on; the banks could lie, they could be running a pyramid scheme; what we DO know is that honesty is in everyone's best interests...

Absolutely!  We should all demand honesty from the banks, and an end to the pyramid scheme that is going on.  However, my point is that shutting down the literal printing presses, which Bitcoin does when it gets to 21,000,000BTC, does not do this.

You're forgetting that Bitcoins are not an inflationary regime. It will be much more difficult to keep the correct number of Bitcoins on hand when you can't just print them willy nilly.

I think you're both right and wrong here.  Yes, it would be more difficult to keep a day's supply of bitcoins on hand when you couldn't request more cash.  However, I also believe that, under bitcoins, no one would *EVER*, or almost ever, request real bitcoins.  Today, people know the difference between a piece of paper with a picture on it and a number on a bank website.   Even though they don't understand the bank's fraud, they know there's something different about the electronic number and the paper.  Therefore, the bank must keep paper on hand, because people might demand it, believing it to be more secure than the bank number on the screen.  However, the distinction between bitcoins and bank balances is *much* more difficult to grasp.  If you're a computer scientist, if you've read the bitcoin whitepapers, etc, you know that there's a difference between a real bitcoin and a number on a bank account website.  The real bitcoin is cryptographically generated, and is not a lie.  Its even far more true in its value than the US paper money, which is what bitcoin is going for.  However, for 99.99% of the population, there is *no* difference between a bitcoin and a bank's fraudulent claim that bitcoins are in an account.  So, no one would ever (or would very rarely) demand bitcoins, making the number that the bank had to keep on-hand far more manageable, and in fact probably just a bit above 0.

"However, I also believe that, under bitcoins, no one would *EVER*, or almost ever, request real bitcoins. "

Why not? It's much easier to do so than it is to request a bar of gold, or even 1 million in physical cash.

You cannot have continual "virtual" inflation without a corresponding decline in the % of real reserves of Bitcoin. Such a system is inherently unstable since it increases the risk with every passing day.

Don't forget that banks are customers of each other, too. Maybe the average Joe won't care, but the larger the balance, the more people will care. I will bet you that banks will care that their deposits are being held in good hands.

I essentially agree with everything you say, but I see the dynamics as being different because there's no Big Daddy to bail the kids out from their mistakes when they mess up, yet again

I agree that the fact that bitcoins are separate from any government makes a difference.  Its a significant difference, and probably the biggest difference between bitcoins and dollars, pounds, euros, or whatever.  However, I think that fractional reserve bailouts could still happen, unfortunately, because people will not demand real bitcoins, not knowing the difference between a bitcoin and a bank balance.

I think it will be much easier to demand real bitcoins; in fact, I would expect that those with large balances (other banks, rich players, etc...) would follow their holdings with close scrutiny, as they have the most to lose from fraud in the banking system.

To summarize, I think we both agree on the mechanics of the banking system. Where we disagree is if everyone can be fooled under a Bitcoin banking system. I don't think they can. Even if 999 average joes with 50 BTCs each are fooled, all you need is ONE guy with a hundred thousand BTCs to keep the entire banking system in line.

This isn't to say fractional reserve banking won't happen, but it will balance at the point where the supply & demand for money balance out. I fully expect that it will take the form of on-demand deposits which are 100% reserved and time deposits which can be fractionated.

It cannot continue beyond the point of equilibrium without an ensuing credit bust. The only reason fiat hasn't busted is because the american citizen must use it to pay taxes and all other debts. There is a legal monopoly on the use of force which enforces the survival of fiat. Without such force, there is no way that a banking system that looks like the way things are practiced today could survive over a long period of time.

P.S. I thought I wrote those points? How come all of those quotes have db's name in them

[InterArmaEnimSil]

There is no law when it comes to Bitcoins, other than the law of human action. Sovereign fiat might create new money with impunity, but then again, sovereign fiat is required to pay taxes and it is legal tender. Bitcoin shares none of these "advantages". Nobody will accept "loans upon loans upon loans" if they are not required to by force of law (and they defacto aren't; please read the Agorism post ), as the further this goes, the more unstable things get. I'll reply in more detail to your other post.

They *will* accept loans upon loans upon loans.  No one forces them to do it today.  Taking out a loan is what creates the vast majority of inflation in today's economy.  Want a house?  If you get a mortgage, you inflate the currency.  You also accept "loans upon loans upon loans."  So, don't get a mortgage.  You also save yourself from the risk of foreclosure, from interest payments, and from a myriad of legal fees if you just buy a house with dollar bills.  You could do that today.  Go down your street, though, and poll the people - "What percentage of homeowners do have or have had a mortgage?" The result will be well in excess of 95%.  No one forced them to accept loans upon loans, but they did, because they wanted a house now that they didn't have the money to buy. Greed made them accept the fictitious idea that loans can back loans, be those loans in whatever currency you wish. The same will happen with bitcoins.

You claim that "there is no law when it comes to bitcoins other than the law of human action."  This is true, but there are two caveats to that statement.
1) There is no law now, because the system at its current size is no threat to government control.  As soon as it is, there will be laws.  The government may not have the power to print the money, but they have the power to enforce...whatever they wish.

2)My quote about loans upon loans stands whether we're talking dollars, bitcoins, gold, or cigarettes.  Whatever your basis of money, there are two options - A)Banks must have X% in reserve at all times, and debt loans don't count, or B)Banks must have X% including debt loans on reserve.  The law in developed nations is that banks are entitled to count debt loans of bank balances *as backing toward identical loans.*  Whether these loans are indollars or bitcoins doesn't matter - the law on how the banks are allowed to operate is the same.  The state does not require banks to keep any percentage of paper dollars backing loans, and so the law stands that, with bitcoins, they wouldn't have to keep any percentage of real bitcoins backing loans.  The law is about the loan practice, not the currency.  We could use seashells for currency, and the law would apply just the same.

Except with Bitcoins, there is no force to keep people captive to a system that they know is ripping them off and no monetary pumping to paper over losses. No taxes, no legal tender laws. Anything operating in the Bitcoin economy survives (and fails) on its own merits alone.

Why not?  The banks are legally able to rip them off with fake, invented bitcoins that exist only on balance sheets, just as they're allowed to with dollars.  If people don't want to go to the banks and only use real bitcoins, then fine.  But people can opt not to go to the banks today - they just choose to go to the banks, to take out loans that invent fake money (and which, in a bitcoin economy, would invent fake bitcions).  Thus, these people's complicity with the banks would inflate the bitcoin economy, just as they do the dollar economy.  Also, as US law stands, taxes must be paid on *dollar equivalent wealth.*  Get some stock benefits as part of your paycheck?  If they are theoretically convertible to dollar value, then you must pay taxes on them.  Generate bitcoins?  If you fail to report the income of the exchange-rate dollar amount of these coins, you *are committing tax evasion in the United States.*  There are tax laws.  The government might not track you down, might not prosecute you, might not even know, but the crime is being committed, whether you're caught or not.  Also, what's to prevent such "captive" laws as you mention from taking hold, as they surely will once (if) bitcoins take off?

So we both agree that the laws suck. However, these laws are just arbitrary points that have nothing to do with market forces and the banking system only survives because there is a lender of last resort. Such a lender of last resort cannot exist in a hard money system such as Bitcoin.

Its true that banks are a lender of last resort.  But my guess is, in a bitcoin economy, if someone wants to buy say, a house, they're going to have to go to a lender of last resort.  Otherwise, they'd have to have enough friends lend them enough money to buy the house...which they could do today.  They don't do it today, though, they go to banks, because your friends don't want to take that kind of a risk (or don't have that much money).  Why can such a lender not exist in a bitcoin system?  There were gold-coin lender banks in hard-money systems before dollars...there will be bitcoin lenders of last resort as well.  They can exist and they will, not because people are forced by law to use them, but because they will hand over the money to buy a house or a car, an Joe and Shirley want that shiny new BMW now, not when they've saved for it.

Fraud should be illegal, yes. If a bank says "Hey, we only keep 10% of your money on hand, so it might not be there when you want it!", then it is no longer fraud, but good luck attracting depositors
Again, if it were not for legal tender rules and taxation, fiat currency would have a value of 0 with the kind of system we have in place today.

Funny you should say that.  They attract *millions* of depositors.  Do you not have a single bank account?  I have several.  This 10% rule (close to that amount, at least) is how *all US banks* operate today.  They attract depositors - there's no way to deny it.  However, you're right that fiat has no value without the decree that it must.  We can wholeheartedly agree on that.

Don't like the word "private" fool you: The Federal Reserve as as much an arm of the government as is the Treasury, Congress, or anything else.
Why would nobody ever question them? Why would anyone even pay any attention to them? They can say they have 10 million Bitcoins, but who cares? There is a limit to the amount of lying that can go on. "You can fool some of the people all of the time, and all of the people some of the time, but you can not fool all of the people all of the time."

Well, you're right that the Federal Reserve might as well be part of the government.  Of course, Ron Paul and Dennis Kucinich(sp?) would say that the government is subservient to the Reserve...but that's another matter.  To quote Mr. Kucinich, "The Federal Reserve is as 'federal' as Federal Express."  You're also right that there's no guarantee that the people would pay attention to a Bitcoin-Fed, but what prevents the US government from passing a law requiring people to take their word, just as they have with the real Fed?  The fed wouldn't have all the bitcoins they claimed, but they don't seriously have the money they claim to have now, but there's nothing we can do about it without utter anarchy.  My point is that there's nothing inherent in the Bitcoin technology or system that makes a government requiring a people trust an obviously underfunded bank impossible.  Likewise, inflation will still occur, even though it will be, like today's dollar inflation, by virtue of lie-bitcoins just like lie-dollars.

"However, I also believe that, under bitcoins, no one would *EVER*, or almost ever, request real bitcoins. "

Why not? It's much easier to do so than it is to request a bar of gold, or even 1 million in physical cash.
You cannot have continual "virtual" inflation without a corresponding decline in the % of real reserves of Bitcoin. Such a system is inherently unstable since it increases the risk with every passing day.
Don't forget that banks are customers of each other, too. Maybe the average Joe won't care, but the larger the balance, the more people will care. I will bet you that banks will care that their deposits are being held in good hands.

No one will ever request real bitcoins because people will be ignorant of the difference between bitcoins and bank balances because they won't know the difference?  Why would they prefer to work with bitcoins?  Both are just numbers on the screen to anyone who doesn't understand cryptography and computers.  At least with paper dollars, the average Joe can see the difference.  With bitcoins and bank balances, people would believe them to be *identical,* and of course all the banks would say how much easier it is to use your bank balance - after all, with it all you need is a debit card, not a client, connection, and your wallet file.  Thus, banks would only have to keep a minuscule number of bitcoins on-hand, because unless someone was a techie, there would be no difference between the account and "cash" bitcoins.

As far as the virtual inflation without a corresponding increase in cash...I really don't know how to argue this, besides to say that you can, and you do, have it today.  Yes, you have real inflation, but you have *far* less real inflation than virtual inflation today.  Similarly, you could have virtual inflation (maybe less, but the argument was about whether bitcoins are completely inflation-proof) with bitcoins, because people don't realize that bank balances made from loans do not exist in any way.  They spend these loan-dollars without realizing they're fake, and more are created every day, and fake loan-bitcoins would be no different.  The system is inherently unstable, yes - Greece right now is an example of what happens.  But the system would exist with bitcoins.  The only way out is to make (by government decree) the practice of creating fake liquidity with loans illegal.  Its not illegal now, and it wouldn't be illegal with bitcoins without a change in the law, which the adoption of bitcions does not guarantee.

Will the banks eventually care that their money is fake-money?  You would think so...you would hope so.  It makes sense.  But 99% of today's money is fictitious...as long as they can buy groceries and yachts and jets, they don't care.  I wish they would.  Even though the money is fake (as in, not backed by dollar bills or cryptographic bitcoins), its real in that people will accept it as valuable.  The problem is that the economy is inflated when this fake-liquidity is created.  However, if you have ten billion dollars, and you dilute the economy by giving loans so that your ten billion can only buy the goods of nine and a half billion, my guess is, you don't care.  That's the position of the banks today.

I think it will be much easier to demand real bitcoins; in fact, I would expect that those with large balances (other banks, rich players, etc...) would follow their holdings with close scrutiny, as they have the most to lose from fraud in the banking system.

I agree that the big players would follow their money closely.  Today, the big players have gold, silver, industrial stocks, and diversified currency portfolios - they already follow their money closely, and have items of real value, not fiat cash.  Sure, Warren Buffet and Richard Branson would probably want to have at least a solid portion of their money in bitcoins.  Even Buffet and Branson and Gates, however, only make up a small portion of the economy.  The rest of the seven billion schmucks on the planet wouldn't want bitcoins - they wouldn't know the difference between a bank website and a bitcoin client.

I decided that my small tech consulting business - just me, really - would accept bitcoins as payment.  I sent out an email to all of my clients.  I got back replies, and *all* of them basically said "WTF is this?"  People barely know the difference between paper and bank websites.  They wouldn't know the difference at all between bitcoins and bank balances, and thus wouldn't see any reason to request real bitcoins.

To summarize, I think we both agree on the mechanics of the banking system. Where we disagree is if everyone can be fooled under a Bitcoin banking system. I don't think they can. Even if 999 average joes with 50 BTCs each are fooled, all you need is ONE guy with a hundred thousand BTCs to keep the entire banking system in line.

Now, this is a nice thought.  If the banks got careless, and a consortium of people could accumulate 21,000,001 bitcoins total across all their bank accounts, then they could call the bluff of the entire system.  That's certainly possible under bitcoins, and impossible under the dollar system.  Of course, the public would probably believe those individuals to be "hackers" or frauds, rather than accept that their entire banking system was a joke.

This isn't to say fractional reserve banking won't happen, but it will balance at the point where the supply & demand for money balance out. I fully expect that it will take the form of on-demand deposits which are 100% reserved and time deposits which can be fractionated.

How can you fraction something and still have 100% available at all times?

It cannot continue beyond the point of equilibrium without an ensuing credit bust.

Yes, but then people just blame the "evil bankers" or the "incompetent government," rather than see the real reason for the bust.


By the way, I'm not sure if I screwed up the quote lines...I've been copying and pasting them to make my partial quotes, so my apologies if someone's name is mis-credited.

The issue is not that Bitcoins are or aren't more stable than dollars - They are.  Their creation is independent of the government, they have a fixed amount, etc.  My point is that inflation will occur in a bitcoin economy.  The website states that it wouldn't, but this is simply untrue unless you change the law.

This is because banks will create fake liquidity by giving out loans which aren't backed by real bitcoins, just as they give out loans that aren't backed by dollars today.  This will not inflate the number of real bitcoins in the system, but it might as well, because it introduces new bitcoin-value-units into the economy. 

Could the banks get caught?  Yes.  Is it easier to catch the banks?  Well, yes, much easier, if people demand real bitcoins...but at the same time, much harder, because the difference between a bank balance and a bitcoin is not at all obvious to average people, leading them to trust bank balances even more than they do now.  ("What?  You mean that's not the exact same thing?  But they're both numbers on the computer!") 

Hopefully, the banks would hold themselves more in line because they would know that if a few people got smart, they could *prove* that the money wasn't backed by bitcoins by accumulating a mutual balance of over 21,000,000.  However...at that point, people would be trusting the balances anyway, so what would it matter?  We'd be back to dollars essentially, just paperless ones. 

The *only* way to prevent inflation is to tell banks "You must back your loans in bitcoins.  You cannot loan out balances which are not backed by bitcoins that you have on file."  This, however, requires the government to step in and mandate that the banks used bitcoin-backing for their loans.  Not only will this not happen, because the government would then be unable to spend like there's no tomorrow, but it would make bitcoins a government-endorsed, and almost certainly government-regulated currency...and we all know what fun government-regulated currencies are.

In short, just because you cannot print additional bitcoins does not mean that the economy will not be inflated.  To prevent backless-bank-loan-inflation, the law would have to be changed.  The implication that a bitcoin economy would be free from inflation should be removed from the website.  If the lead programmer or whomever maintains the site chooses to replace it with "inflation free given a change in monetary policy law," that's fine, but bitcoins do not prevent inflation, because inflation comes, at least the great majority of it, from loans rather than actual printing of cash.