Bitcoins and loans

[Rival]

I have been trying to figure out how loans could work in a deflationary currency. Borrowing bitcoins would be a pretty bad idea overall, considering that if the loan were amortized over a period of years, even at some microscopic interest rate, the coins you use to pay it back could have a value of many times the initial loan value. It would be suicidal to take out such a loan.

However, it occurred to me that bitcoins would make the most amazing collateral. No one in their right mind would consider defaulting as prices rise. Suppose with btc at $1000 each. You borrow $1000 against a coin. BTC rises to $5000 per coin in the time before the loan comes due. I am pretty sure you would find the $1000 to get your coin back one way or the other.

Obviously, the lender would need to hedge the price of the coin he is holding for collateral because if the value dropped to $500 per coin the chances of default increase dramatically. But overall, I think using BTC as collateral may be a viable system, much better than making loans denominated purely in BTC.

What say you?

[odolvlobo]

Eventually, the exchange rate won't be rising as quickly as it is now and it will maybe rise 1% - 3% per year. When we talk about bitcoin being deflationary, that is the kind of rate that is expected. Basically, nobody will lend bitcoins until the deflation rate drops below the prevailing interest rates.

[JoelKatz]

However, it occurred to me that bitcoins would make the most amazing collateral. No one in their right mind would consider defaulting as prices rise. Suppose with btc at $1000 each. You borrow $1000 against a coin. BTC rises to $5000 per coin in the time before the loan comes due. I am pretty sure you would find the $1000 to get your coin back one way or the other.

That won't work. If the lender believes that Bitcoins are so likely to appreciate, he'd just buy Bitcoins with his money instead of loaning them out.

Your entire chain of reasoning starts from an impossible hypothetical where there exists an asset that is sure to outperform other investments that people might consider. That is impossible. If there ever were such as asset, nobody would invest in anything that wasn't expected to outperform it.

There's another reason the scenario imagined is impossible. It requires people to value a Bitcoin next year higher than a Bitcoin today. But that's impossible. Clearly a person would rather have a Bitcoin today than a Bitcoin next year because one of the things you can do with a Bitcoin today is hold it until next year. A Bitcoin today includes as part of its value the right to hold it until next year and enjoy its higher value if its value is higher. So everyone would have to be irrational to value future Bitcoins higher than present Bitcoins.

In fact, it was just this kind of reasoning about home mortgage loans that lead to the financial system's collapse.

[aminorex]

Your entire chain of reasoning starts from an impossible hypothetical where there exists an asset that is sure to outperform other investments that people might consider. That is impossible. If there ever were such as asset, nobody would invest in anything that wasn't expected to outperform it.

And yet, here we are.  The situation is such that BTC is sure (for practical P values) to outperform other investments that people might consider. Personally I conclude that folks are either unwilling to endure the wait or unduly fearful of low probability events or just plain ignorant.  Mostly just plain ignorant would suffice to explain just about everything.

[JoelKatz]

Your entire chain of reasoning starts from an impossible hypothetical where there exists an asset that is sure to outperform other investments that people might consider. That is impossible. If there ever were such as asset, nobody would invest in anything that wasn't expected to outperform it.

And yet, here we are.  The situation is such that BTC is sure (for practical P values) to outperform other investments that people might consider. Personally I conclude that folks are either unwilling to endure the wait or unduly fearful of low probability events or just plain ignorant.  Mostly just plain ignorant would suffice to explain just about everything.

So, if everyone were rational, they would all invest in Bitcoin and everyone would be many times wealthier than they are? Where would the wealth come from?

[thaaanos]

I am inclined that no loans nor savings Bank are possible in a bitcoin economy, with whatever that adds up to a general deflationary process.
I cant even guess how the insurance market is going to behave...
I only see low risk private capital investments on a as needed basis.

If anyone expects growth to occur, he is welcomed to show us how...

[JoelKatz]

I am inclined that no loans nor savings Bank are possible in a bitcoin economy, with whatever that adds up to a general deflationary process.
I cant even guess how the insurance market is going to behave...
I only see low risk private capital investments on a as needed basis.

If anyone expects growth to occur, he is welcomed to show us how...

So you're saying that even though there will be little to no growth, Bitcoins will still constantly increase in value? If there isn't lots and lots of growth, the value of Bitcoins can't keep going up (where will the value come from?). Unless the value of Bitcoins keeps going up, loans and banks won't be discouraged.

[thaaanos]

I am inclined that no loans nor savings Bank are possible in a bitcoin economy, with whatever that adds up to a general deflationary process.
I cant even guess how the insurance market is going to behave...
I only see low risk private capital investments on a as needed basis.

If anyone expects growth to occur, he is welcomed to show us how...

So you're saying that even though there will be little to no growth, Bitcoins will still constantly increase in value? If there isn't lots and lots of growth, the value of Bitcoins can't keep going up (where will the value come from?). Unless the value of Bitcoins keeps going up, loans and banks won't be discouraged.

by withdrawing bitcoins from circulation? a self-reinforcing scrooge loop?
At least until people see how ridiculus that is and decide to switch to another currency.

[Rival]

The value of bitcoins is already derived from the same place that it will continue to draw from: The capital represented by other currencies. Every time bitcoins increases in value by $1.00, all of the dollars in circulation lose one quadrillionth of a cent of value. The representation of capital already exists, it is just moving from one form to another. In this case, from fiat to bitcoin. This can certainly continue until such time that all fiat has no value, and all capital is expressed by bitcoin.

Before that occurs though, as stated in the original post, bitcoin can be used as the perfect collateral for fiat loans. To me it makes perfect sense to use an appreciating asset as collateral. You still have a claim upon that asset, assuming you can pay back your inflationary fiat loan as required. Kind of like pawning your bitcoins for dollars. Come back in 3 months, pay off the loan, and get your coin back. This is the basic model of how lending occurs when you have a deflationary currency and an inflationary currency existing side-by-side.

Bitcoins may eventually not be valuable because they can be spent (a currency) but rather because they are the required collateral to procure fiat loans.