Loans in a Bitcoin world

[d5000]

We all want Bitcoin to replace fiat, right? And banks too.

Well, one of the things that needed to be replaced is the feature of banks to provide loans. Loans are important for businesses, but also for consumers if they want to finance costly goods like houses and cars.

In a Bitcoin world, where everything is tied to BTC's value, this can lead to some complications. First there is of course volatility - it could be risky to take a loan in a Bitcoin bull market because what you would have to repay it could have a substantial higher value than what you got as loan, with a high risk of insolvency.

But let's assume the volatility problem has been solved, there's still a challenge. Current banks, when they give out a loan, create an amount of money on the account of the borrower. This money can be instantly moved to be used for payments. In reality it's a relatively complex process if we take into account clearing and interbank loans, but we can say that the fractional reserve system enables a high availability of loans at any time.

In a Bitcoin world however, a fractional reserve system can be imagined (like Hal Finney proposed it here in the forum in 2010) but it would be very risky for banks, because there is no Central Bank and thus no lender of last resort. Banks would never be able to operate with a reserve as low as the 1% currently standard in Europe and the US, but probably need reserves of 30 or even 50%. This would indirectly lead to less availability for loans, a situation called credit crunch or credit squeeze.

This is even aggravated by another problem: in a Bitcoin world bank accounts are not really necessary because you can use always a wallet, so there would be less deposits on banks.

From all I understand this would mean that less availability of loans would mean much higher hurdles to build up businesses, but also for consumers to finance their houses and cars. Economy would suffer a slowdown (at least if the other Capitalist mechanisms stay the same).

Do we have a solution for that? Well, those are some I can think of:
- ICOs, STOs and other token mechanisms. They would surely be a very popular way for medium- to large businesses to get money, and if regulations are not too strict, also for smaller ones. But the problem of an ICO is that you always need something "sellable", easy to understand for investors. So it's not a tool for everyone.
- Bartering. One could imagine bartering platforms based on tokenized (smart property) goods and services, where businesses could lower their need for liquidity bartering their own services for others. This however depends on the business already having a product/service.
- P2P lending. This could be something interesting for consumer loans, but the liquidity I expect to be relatively low, too.
- Loans in Bitcoin-based stablecoins. I think here of something like Bitshares' BitBTC. These would be created by speculators shorting BTC, and can create additional BTC units even if they're not directly backed by "existing" Bitcoins.
- DeFi-style lending (cryptos as securities for other cryptos). This unfortunately today has very few use cases, because it needs crypto-securities as collateral. Maybe it could be combined with the tokenized smart property approach.

I would be interested in your opinions. Is my interpretation of a possible credit crunch right? What about the possible solutions I listed? Are there alternatives and even better ones?

I've not studied economics, so I may be wrong, but from my limited knowledge in the area that's what I think that could be issues the Bitcoin community would have to solve before really reaching mass adoption.

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[Upgrade00]

If Bitcoin had effectively replaced fiat, that should solve the issue of volatility as it doesn't have to be liquidated into other currencies (which would hypothetically no longer be in use).
I'm not an expert in the field, so I can't also explain the intricacies of how a Bitcoin powered economy would function, but it would definitely be different from what we have now.

This is even aggravated by another problem: in a Bitcoin world bank accounts are not really necessary because you can use always a wallet, so there would be less deposits on banks.

The liberty to choose whether or not to use a financial institution could be seen as an advantage rather than a problem by some people.

[fillippone]

I have been approaching DeFi lately, not really willing to invest in that, but only to really understand what is it and how it works in details, as a lot of people I am asking how it work cannot properly answer my question.
The only aspect DeFi can be through is to reinstate some kind of Bitcoin Standard, ad the Gold Standard was in place between Bretton Woods and 1971.
As you lend your Gold to the Bank, and you get a private Fiat COIN (think à la Hajek a competition between private moneys, not a real law enforced FIAT money), then now you lend your digital decentralised Gold (BTC) to get some kind of decentralised money.
The fact that it is possible to borrow and lend this money could stimulate a new decentralised, trustless and efficient decentralised finance to bootstrap a new economy based in bitcoin.

The reality is that today (Jul 2020)  DeFi is still a ICO-greed-FOMO driven pump.

[bitmover]

At the current adoption stage,  loans make no sense imo. Only in casinos or similar websites that need crypto, not fiat.

If you need 10k usd, why would you ask for a 1 btc loan? To sell that btc, convert to usd and then buy btc back to repay?

Volatility is so high that both parts would like to convert the value of loan to fiat, not btc.

[Darker45]

It appears a very complicated problem to me. I guess we just have to admit that Bitcoin by design cannot fully support all the features and services that banks are currently providing to its clients. Neither is Bitcoin designed to fully support an entire country's economy. I'm afraid the hard-coded system is simply not as flexible as it should be.

Which brings us back to step one and ponder deeply whether or not we really "all want Bitcoin to replace fiat... And banks too." Or perhaps we should settle as the main alternative currency or as the one global currency.

A credit crunch is very possible which may result to Bitcoin-based loans offered only in relatively small amounts. Cars and houses may easily be accommodated but not huge industrial loans coming multi-billion companies or large development loans to build massive government infrastructures. 

[mu_enrico]

Loans in the Bitcoin world is such a complicated problem to solve! Let's start with the hypothetical scenario about the Bitcoin value, which is always increasing over time. In this imaginary world, no one will be incentivized to lend and borrow Bitcoin. Lenders need an incentive to provide liquidity, usually in the form of interest, while borrowers need stability (fixed interest and repayments). If the Bitcoin value increases over time, borrowers will find it more challenging to repay the debt (principal + interest), which makes it undesirable to borrow money and then drive interest rates to zero. When the interest rate is zero, the capitalist would think, why would I risk my Bitcoin if I can just hoard it in my wallet.

[teosanru]

I have really looked into this loan mechanism in Bitcoin. I have tried to researched a lot and tried to make some sensible flowchart but unfortunately nothing striked. To be really true loan system in bitcoin is just not possible. It could work in short term like defi are doing or some people do but making a large, robust and value adding system is not possible until the lender and the buyer are legally bound to repay each other therefore are in one country. Because the biggest challenge is repayment. Generally bitcoin loans would be tied with certain charge of interest. Now price volatility is a big issue when the price increases lender would just not return the loan because even practically it doesn't makes sense for him. Moreover, sort of defi structure might ensure that lenders have enough liquidity but problem is collateral? Collateral around the Web can be pretty diverse. You would need a specific interaction with every lender to understand his collateral which does not makes sense. Most of the time defi asks for collateral such as other cryptocurrency which is absolute nonsense. Why would I pay interest for borrowing a liquid cryptocurrency by keeping with you another liquid cryptocurrency of similar value? Even if you say that keep a reserve of 80% then we are back to ground zero that lender just won't pay back in even normal cases and he is under no legal obligation. P2P lending also faces the same issue.

[fillippone]

I have really looked into this loan mechanism in Bitcoin. I have tried to researched a lot and tried to make some sensible flowchart but unfortunately nothing striked. To be really true loan system in bitcoin is just not possible. It could work in short term like defi are doing or some people do but making a large, robust and value adding system is not possible until the lender and the buyer are legally bound to repay each other therefore are in one country. Because the biggest challenge is repayment. Generally bitcoin loans would be tied with certain charge of interest. Now price volatility is a big issue when the price increases lender would just not return the loan because even practically it doesn't makes sense for him. Moreover, sort of defi structure might ensure that lenders have enough liquidity but problem is collateral? Collateral around the Web can be pretty diverse. You would need a specific interaction with every lender to understand his collateral which does not makes sense. Most of the time defi asks for collateral such as other cryptocurrency which is absolute nonsense. Why would I pay interest for borrowing a liquid cryptocurrency by keeping with you another liquid cryptocurrency of similar value? Even if you say that keep a reserve of 80% then we are back to ground zero that lender just won't pay back in even normal cases and he is under no legal obligation. P2P lending also faces the same issue.

At the moment you are right.
Given price volatility, or rather price direction, only a fool would ask a loan in Bitcoin.If it is true that "throw good money after bad", you want to spend bitcoin after your FIAT money, so you actually want to take a loan in the bad money (FIAT). So at the moment DeFi works because there are many "crypto only rich", who cannot have a FIAT loan (remember interest rates are negative in large part of the world!), and so are ofrced to ask a loan in crypto.

I think that with mass adoption, and with a more complete price discovery of Bitcoin, volatility will eventually come down, allowing a more widespread use of Bitcoin in a lending economy. Again, as I said in my above message a "bitcoin standard".

[hatshepsut93]

In a Bitcoin world however, a fractional reserve system can be imagined (like Hal Finney proposed it here in the forum in 2010) but it would be very risky for banks, because there is no Central Bank and thus no lender of last resort. Banks would never be able to operate with a reserve as low as the 1% currently standard in Europe and the US, but probably need reserves of 30 or even 50%. This would indirectly lead to less availability for loans, a situation called credit crunch or credit squeeze.

This assumes that Bitcoin will be a dominant currency of the world, which is likely not gonna happen. So, even if 5% of the economy will run on Bitcoin, Bitcoin's deflation won't be a big problem.

So, there totally will be Bitcoin lending and banks, they probably will be very strict with their clients, like you'll have to physically show up to open a bank account, prove that you can fulfill obligations, etc. So, there will be much less private uncollaterized loans. This all will make kinda hard for Bitcoin banks to compete with fiat, cause I don't see any reason to take a Bitcoin loan over a fiat loan.

[teosanru]

I have really looked into this loan mechanism in Bitcoin. I have tried to researched a lot and tried to make some sensible flowchart but unfortunately nothing striked. To be really true loan system in bitcoin is just not possible. It could work in short term like defi are doing or some people do but making a large, robust and value adding system is not possible until the lender and the buyer are legally bound to repay each other therefore are in one country. Because the biggest challenge is repayment. Generally bitcoin loans would be tied with certain charge of interest. Now price volatility is a big issue when the price increases lender would just not return the loan because even practically it doesn't makes sense for him. Moreover, sort of defi structure might ensure that lenders have enough liquidity but problem is collateral? Collateral around the Web can be pretty diverse. You would need a specific interaction with every lender to understand his collateral which does not makes sense. Most of the time defi asks for collateral such as other cryptocurrency which is absolute nonsense. Why would I pay interest for borrowing a liquid cryptocurrency by keeping with you another liquid cryptocurrency of similar value? Even if you say that keep a reserve of 80% then we are back to ground zero that lender just won't pay back in even normal cases and he is under no legal obligation. P2P lending also faces the same issue.

At the moment you are right.
Given price volatility, or rather price direction, only a fool would ask a loan in Bitcoin.If it is true that "throw good money after bad", you want to spend bitcoin after your FIAT money, so you actually want to take a loan in the bad money (FIAT). So at the moment DeFi works because there are many "crypto only rich", who cannot have a FIAT loan (remember interest rates are negative in large part of the world!), and so are ofrced to ask a loan in crypto.

I think that with mass adoption, and with a more complete price discovery of Bitcoin, volatility will eventually come down, allowing a more widespread use of Bitcoin in a lending economy. Again, as I said in my above message a "bitcoin standard".

Even if we get a mass adoption. Problem persists on the borrower side. How do we incentivize the borrower to payback just like mu_enrico mentioned. Like there is no legal obligation and threat of recovery by forceful means if you don't pay back. Maximum you will have is that you can't take a loan again on that platform. But then again there would be number of platforms. If we think of some central credit score which every lender has that also doesn't works due to pseudo-anonymity of users. Fake KYC documents are pretty easy to grab. Bitcoin standard might help in arrangement of funds but problem of non-traceability or difficulty in traceability would always hamper lender's power to enforce repayment.

[davis196]

Loans in the Bitcoin world is such a complicated problem to solve! Let's start with the hypothetical scenario about the Bitcoin value, which is always increasing over time. In this imaginary world, no one will be incentivized to lend and borrow Bitcoin. Lenders need an incentive to provide liquidity, usually in the form of interest, while borrowers need stability (fixed interest and repayments). If the Bitcoin value increases over time, borrowers will find it more challenging to repay the debt (principal + interest), which makes it undesirable to borrow money and then drive interest rates to zero. When the interest rate is zero, the capitalist would think, why would I risk my Bitcoin if I can just hoard it in my wallet.

Yeah,but the interest rate can be flexible,so when the Bitcoin price goes up,the interest rate of the loan might go down.I know this doesn't solve the problem of a huge price boost of BTC,that will make the borrower go bankrupt.
Anyway,Bitcoin is a deflationary currency,which makes it really hard to be used for loans.
Inflationary currencies,that are slowly losing their value,are better for lending,because the lender will get interest,that will preserve the value of his capital.
Bitcoin is just like gold.Do you see anyone in the world giving gold loans?No,because everybody expects that the value of gold will go up.
 

[Lorence.xD]

I can't see how loan system will work in bitcoin, the supply is limited and there isn't enough in the circulation, if you were to let someone borrow your bitcoin then it will take a long time before they can pay it, loans is a big thing for me because this can destroy financial stability or could help build a foundation to make someone stable, I do believe that this will not work if ever there is a system that will be implemented.

[tvplus006]

..If you need 10k usd, why would you ask for a 1 btc loan? To sell that btc, convert to usd and then buy btc back to repay..

Such a scheme might work in the case when bitcoin was trading at higher levels. Such a loan operation would be similar to margin trading on a cryptocurrency exchange. Thus, the lender receives not only finance in debt, but also earns more on the exchange rate of BTC.

[HeRetiK]

In a Bitcoin world however, a fractional reserve system can be imagined (like Hal Finney proposed it here in the forum in 2010) but it would be very risky for banks, because there is no Central Bank and thus no lender of last resort. Banks would never be able to operate with a reserve as low as the 1% currently standard in Europe and the US, but probably need reserves of 30 or even 50%. This would indirectly lead to less availability for loans, a situation called credit crunch or credit squeeze.

This assumes that Bitcoin will be a dominant currency of the world, which is likely not gonna happen. So, even if 5% of the economy will run on Bitcoin, Bitcoin's deflation won't be a big problem.

Pretty much this. Even if Bitcoin becomes dominant, the way we currently run our economy still requires a form of inflationary fiat currency.

In a completely crypto dominated utopia this may even be private money in the form of centrally issued tokens, although it's more likely to remain governmental currencies. The thing is, our current understanding of growth-based economy requires a heavy amount of forward-looking loaning to function, ie. businesses borrowing money "from the future" to allow for growth in the present. This system unfortunately only works if the loans are based on an inflationary currency, otherwise businesses end up short on money in a literal way, ie. with a deflationary currency you can't take money "from the future" without it missing somewhere else -- it turns into a zero sum game where any economic growth on one side can not happen without a bankruptcy on the other.

Accordingly I do believe that even in a Bitcoin world most loans would still have to run on fiat. Everything else just doesn't add up, at least as long we insist on our economies to grow or unless economics undergoes a major paradigm shift.

[fillippone]

Accordingly I do believe that even in a Bitcoin world most loans would still have to run on fiat. Everything else just doesn't add up, at least as long we insist on our economies to grow or unless economics undergoes a major paradigm shift.

This is the point. We need a big paradigm shift. 
Credit is ok. Banking is ok. In a word: hard money is of.
What is not ok is central banking providing infinite credit to infinite borrowrs without accountability.
This is what is dangerous: not credit per se, but credit without the penalty of the loss if the borrower gets in trouble.

This is what bitcoin fixes. Credit in a deflationary environment urges the lender to accuratley select the borrower's projects to pick the one qwit hthe greatest chance to repay his preciuous ddeflationalry money.

[Febo]

If Bitcoin had effectively replaced fiat, that should solve the issue of volatility as it doesn't have to be liquidated into other currencies (which would hypothetically no longer be in use).
I'm not an expert in the field, so I can't also explain the intricacies of how a Bitcoin powered economy would function, but it would definitely be different from what we have now.

If everyone would use Bitcoin instead of fiat and its value would change as fast as right now nothing would be changed. 1 Bitcoin today is 5000 loaves of bread and tomorrow, because Chinese president make a statement , will be $6000 loaves of bread. That is a problem, but I believe it is a problem only now since Bitcoin is not used enough. Once adoption will be wide volatility will go away and Bitcoin will be way more stable as right now. 

[HeRetiK]

Accordingly I do believe that even in a Bitcoin world most loans would still have to run on fiat. Everything else just doesn't add up, at least as long we insist on our economies to grow or unless economics undergoes a major paradigm shift.

This is the point. We need a big paradigm shift. 
Credit is ok. Banking is ok. In a word: hard money is of.
What is not ok is central banking providing infinite credit to infinite borrowrs without accountability.
This is what is dangerous: not credit per se, but credit without the penalty of the loss if the borrower gets in trouble.

This is what bitcoin fixes. Credit in a deflationary environment urges the lender to accuratley select the borrower's projects to pick the one qwit hthe greatest chance to repay his preciuous ddeflationalry money.

Except in practice this "urge to accurately select the borrower's projects" doesn't work out quite as well. I mean people are sending coins to scammers to double their money FFS (╯ಠДಠ)╯

We need a paradigm shift that goes beyond underdelivering ICOs, cloudmining ponzis and thinly veiled HYIP scams. A new understanding of money and economics. Bitcoin delivered on the first one, but we're still far from the second.

[CarnagexD]

At the current adoption stage,  loans make no sense imo. Only in casinos or similar websites that need crypto, not fiat.

If you need 10k usd, why would you ask for a 1 btc loan? To sell that btc, convert to usd and then buy btc back to repay?

Volatility is so high that both parts would like to convert the value of loan to fiat, not btc.

That's a very risky thing to do if you will make loans. You should not rely and settle on the price of bitcoin as its volatility can change its price anytime depending on the market situation. When you will make a loan, make sure that you will loan in USD and not in bitcoin because it can increase the money that you need to pay, and that's worse. The price of bitcoin always change, it is either increase, stable, or decrease.

If Bitcoin had effectively replaced fiat, that should solve the issue of volatility as it doesn't have to be liquidated into other currencies (which would hypothetically no longer be in use).
I'm not an expert in the field, so I can't also explain the intricacies of how a Bitcoin powered economy would function, but it would definitely be different from what we have now.

In most of the discussions, bitcoin's volatility is the main problem that we are facing and we need to deal with that because we had no choice but to manipulate it properly in the market.

I don't think that even if people adopt bitcoin, it will just function just like the same with fiat.

[AniviaBtc]

If Bitcoin had effectively replaced fiat, that should solve the issue of volatility as it doesn't have to be liquidated into other currencies (which would hypothetically no longer be in use).
I'm not an expert in the field, so I can't also explain the intricacies of how a Bitcoin powered economy would function, but it would definitely be different from what we have now.

If everyone would use Bitcoin instead of fiat and its value would change as fast as right now nothing would be changed. 1 Bitcoin today is 5000 loaves of bread and tomorrow, because Chinese president make a statement , will be $6000 loaves of bread. That is a problem, but I believe it is a problem only now since Bitcoin is not used enough. Once adoption will be wide volatility will go away and Bitcoin will be way more stable as right now. 

Bitcoin is really unfair when it comes to sudden changes in its price due to its volatility and most of the bitcoin holders are aware about that. That's why you should not loan in bitcoin but loan in USD, because loaning in bitcoin can bring advantage or disadvantage for you. When you make a loan of 1 bitcoin for example, and the price of bitcoin increases in USD, then that's a bad thing for you. But if a price of bitcoin decreases, then that's a good thing for you. But once the price of bitcoin decreases, you are advantageous of the opportunity to pay BTC that you've loaned in a smaller amount in USD.

[leyton11]

Yes, the crypto market in general and DeFi altcoins are gradually replacing our country's banks. Loans are diverse and we always have lots of choices. Unfortunately, not too many people are interested in this area of lending in the crypto market. I'm afraid that DeFi will only emerge based on its features but lack customers, which will soon cause the DeFi trend to fade. Technology in the crypto market is always an upgraded technology and it will be difficult for everyone to understand its features. This is also a major barrier for potential altcoins in the crypto market.