Fractional Reserve Banking Approach on the Table for Corrupting Bitcoin Network?

[JohnsonRobinson]

Just reading through this article.

Bitcoin: Questions, Answers, and Analysis of Legal Issues
www.fas.org/sgp/crs/misc/R43339.pdf‎

On Page 6
Under heading:  "No Erosion of Purchasing Power by Inflation"
Paragraph 3, Sentence 2:

"Inflation could also occur if the Bitcoin network develops fractional reserve banking (i.e., banks that hold only a fraction of their deposits in reserve and lend out the rest), which would also be a vehicle that effectively increases the supply of circulating Bticoins.


The upper cap on the number of Bitcoins at a known, unchangeable number of 22million, along with a predictable increase in Bitcoins until that number is reached, is absolutely one of its key features for benefiting the masses.  This is because excessive inflation / reduction in buying power through fiat money printing by private central banks is tantamount to theft from the masses.  The Bitcoin network avoids this.


Just wondering, from a technical side, how a fractional reserve banking-based alteration to Bitcoin would be achieved and how we can stop it / protect the bitcoin network from this.

[Holliday]

Just wondering, from a technical side, how a fractional reserve banking-based alteration to Bitcoin would be achieved and how we can stop it / protect the bitcoin network from this.

It would be achieved by getting people to accept promissory notes instead of actual Bitcoins. You probably can't stop it and it doesn't require a network change.

[JohnsonRobinson]

Is there no way of telling that a particular coin has its source in mining rather than a promissory note?

[BurtW]

Eventually some people will accept bitcoin paper.  Once enough people accept Bitcoin paper then they are off to the races again (fractional reserve of actual Bitcoin to create Bitcoin paper, inflation of the paper - not the actual thing, etc.)

However, you personally can always refuse the notes and only accept and hold the real thing.

Is there no way of telling that a particular coin has its source in mining rather than a promissory note?

Your question makes no sense.  A Bitcoin is a Bitcoin, a promise to pay you a bitcoin is just a promise.

[ArticMine]

Very simple take delivery of your BTC, sit back and enjoy the fireworks.

Fractional reserve banking by its very nature involves a short play, namely a promise to pay something one does not have, on the expectation that the lender or "depositor" will not ask for it back or "take delivery". There is no more effective way to squeeze the bears to the wall in any market than to take delivery.

By the way the BTC market saw a sizeable example of fractional reserve banking with pirateat40 and his "trusts" in late 2011 and 2012. I strongly believe that he single handedly depressed the BTC/USD market during 2012 and when it all blew up the price sky-rocketed in 2013. Those of us who were actively buying BTC in 2012 and taking delivery profited handsomely from the pirate affair.

[Holliday]

Is there no way of telling that a particular coin has its source in mining rather than a promissory note?

Actual bitcoins only exist on the block chain. If your bitcoin is on the block chain, it's a bitcoin.

If you accept a note claiming to be a bitcoin, yet you can not manipulate this coin on the block chain, you have a promissory note.

Fractional reserve banking will be easier to keep in check with Bitcoin as we can always see actual bitcoins on the block chain. If a Bitcoin bank wishes to engage in FRB, it's users can demand the bank submit to audits by proving it controls a certain amount of bitcoins on the block chain. The beauty of the block chain is that it is a public ledger which can not be faked.

Now banks can compete for their customer's business by offering good interest rates on deposited bitcoins which they will loan out, yet the customers have methods to keep the banks honest.

Also, promissory notes will probably not be fungible with actual bitcoins (because it's so simple to tell them apart), the real thing will command a premium.

[HairyMaclairy]

Many suspect Mt Gox of engaging in fractional reserve banking hence the fiat withdrawal problems.  

Good luck auditing any exchange they won't cooperate.

By definition any fiat or bitcoin held on an exchange is an IOU.  The comment above is correct in that the market is factoring in a 15% risk premium for Gox USD.   If it is true that Yen withdrawals on Gox are also broken then the 15% premium is too low IMHO.   

[Holliday]

Very simple take delivery of your BTC, sit back and enjoy the fireworks.

Fractional reserve banking by its very nature involves a short play, namely a promise to pay something one does not have, on the expectation that the lender or "depositor" will not ask for it back or "take delivery". There is no more effective way to squeeze the bears to the wall in any market than to take delivery.

By the way the BTC market saw a sizeable example of fractional reserve banking with pirateat40 and his "trusts" in late 2011 and 2012. I strongly believe that he single handedly depressed the BTC/USD market during 2012 and when it all blew up the price sky-rocketed in 2013. Those of us who were actively buying BTC in 2012 and taking delivery profited handsomely from the pirate affair.

Bitcoin opens to the door to transparent FRB. One can enter into a contract with their bank stating that they will deposit and not take delivery of their bitcoins for a certain period of time. The banks will have to offer competitive interest rates in order to get people to enter into these contracts. Of course, unlike pirate@40, the customers would be wise to demand third party auditing of the books.

[ArticMine]

Is there no way of telling that a particular coin has its source in mining rather than a promissory note?

The more relevant question is: Is a particular BTC promissory backed by actual BTC, and if so to what extent.

By the way there may be a situation developing with gold. Just search for "GATA German gold". If the conspiracy theorists are proven correct and this blows up it will have a profound impact not only on the gold market but also on the BTC market.

[Holliday]

Many suspect Mt Gox of engaging in fractional reserve banking hence the fiat withdrawal problems.  Good luck auditing any exchange they won't cooperate.

By definition any fiat or bitcoin held on an exchange is an IOU.

Indeed. One risks losing their deposits by trusting organizations which do not submit to an audit.

[pening]

It worked for gold and other assets for a few hundred years.

In fact, it's inevitable.  You have a situation where people are sitting on large wealth in an asset that doesn't do anything productive.  Sell it and you risk missing long term appreciation.  By loaning it, others can put it to productive use.  

[Holliday]

It worked for gold and other assets for a few hundred years.

In fact, it's inevitable.  You have a situation where people are sitting on large wealth in an asset that doesn't do anything productive.  Sell it and you risk missing long term appreciation.  By loaning it, others can put it to productive use.  

The difference with Bitcoin is that there is a widely distributed public ledger which allows for transparency unlike anything we've had before.

[HairyMaclairy]

Is there no way of telling that a particular coin has its source in mining rather than a promissory note?

The more relevant question is: Is a particular BTC promissory backed by actual BTC, and if so to what extent.

By the way there may be a situation developing with gold. Just search for "GATA German gold". If the conspiracy theorists are proven correct and this blows up it will have a profound impact not only on the gold market but also on the BTC market.

I don't follow gold but know it is claimed the US does not have the German's gold. What would be the impact on the gold market if this is true?  I don't see a direct impact in fiat which is not backed by anything.

[JohnsonRobinson]

This seems like a bit of an opportunity for any new crypto; or for Bitcoin, if it can manage the change...a Fractional Banking-resistant Coin.

Some type of embedded auditing or some type of way to ensure that balances held across exchanges is frequently confirmed against the blockchain...is that even possible?

I do think it is desirable, since, out of control, fractional reserve banking is a bad deal for the masses, and always the biggest benefit to the 'already-rich.'

[HairyMaclairy]

Regarding fractional reserve lending of bitcoin it is a very dangerous game.  If the price jumps by 1000% your debts (measured in fiat) also jump 1000%.  

This can make you insolvent very fast.  My guess is that Gox has been fractional reserve banking bitcoin since day 1 and has been caught on the wrong side of a 10,000% price increase which means they could be $US billions of dollars in the hole.  They can keep going until someone sues them in Japan for not coughing up their fiat (which will happen if not now then on the next price jump).

Ironically this makes new exchanges safer than old ones because they have not had the opportunity to get caught with their pants down for such a huge price swing.  

[HairyMaclairy]

This seems like a bit of an opportunity for any new crypto; or for Bitcoin, if it can manage the change...a Fractional Banking-resistant Coin.

Some type of embedded auditing or some type of way to ensure that balances held across exchanges is frequently confirmed against the blockchain...is that even possible?

I do think it is desirable, since, out of control, fractional reserve banking is a bad deal for the masses, and always the biggest benefit to the 'already-rich.'

The answer is systems where the depositor continues to control the private key or part of a multi sig. 

[JohnsonRobinson]

This seems like a bit of an opportunity for any new crypto; or for Bitcoin, if it can manage the change...a Fractional Banking-resistant Coin.

Some type of embedded auditing or some type of way to ensure that balances held across exchanges is frequently confirmed against the blockchain...is that even possible?

I do think it is desirable, since, out of control, fractional reserve banking is a bad deal for the masses, and always the biggest benefit to the 'already-rich.'

The answer is systems where the depositor continues to control the private key or part of a multi sig.  

That would be good.  I am wondering what the lowest level in the protocol / implementation would be that something like this could be achieved.  The lower the level, the less trust required=better IMO.

[JohnsonRobinson]

It worked for gold and other assets for a few hundred years.

In fact, it's inevitable.  You have a situation where people are sitting on large wealth in an asset that doesn't do anything productive.  Sell it and you risk missing long term appreciation.  By loaning it, others can put it to productive use.  

The difference with Bitcoin is that there is a widely distributed public ledger which allows for transparency unlike anything we've had before.

Yes and probably what concerns the powers-that-be the most.

[HairyMaclairy]

This seems like a bit of an opportunity for any new crypto; or for Bitcoin, if it can manage the change...a Fractional Banking-resistant Coin.

Some type of embedded auditing or some type of way to ensure that balances held across exchanges is frequently confirmed against the blockchain...is that even possible?

I do think it is desirable, since, out of control, fractional reserve banking is a bad deal for the masses, and always the biggest benefit to the 'already-rich.'

The answer is systems where the depositor continues to control the private key or part of a multi sig.  

That would be good.  I am wondering what the lowest level in the protocol / implementation would be that something like this could be achieved.  The lower the level, the less trust required=better IMO.

Pretty sure multi sig is in the core protocol just not implemented yet.  But develpers will be extremely cautious so don't expect it anytime soon.

[johnyj]

FRB is not possible with bitcoin, since people will always prefer to borrow inflative money

And FRB does not create more money , just created an illusion of more money , only QE can create more money