FRB and Bitcoin

[Kilmyos]

I was reading on https://en.bitcoin.it/wiki/Fractional_Reserve_Banking_and_Bitcoin and it states "The Monetary Base of Bitcoin is limited to 21 million. But because Fractional Reserve Banking is possible, the money supply of bitcoins (which includes demand deposits) can greatly exceed 21 million." 

How is this possible? Wouldn't that be equal to a central bank printing money out the ass?

[Kilmyos]

I understand that part, but my question relates to the quote that I mentioned. How can Bitcoins be created out of thin air after the 21million cap is hit?

[Kilmyos]

I'm obviously missing something, what does "money supply" mean other than the total amount of Bitcoins in existance?

[barbarousrelic]

A fractional-reserve bank can tell you you have Bitcoins on deposit which are not actually in their possession. Thus, if enough people believe such fraudulent bankers, the *apparent* number of Bitcoins can increase past 21 million. But the blockchain will only ever reflect 21 million.

[kokjo]

I'm obviously missing something, what does "money supply" mean other than the total amount of Bitcoins in existance?

there will only be 21 mil. REAL btc. but you can still OVER lend them. and thereby creating virtual BTC.
eg. i put 100 btc in a bank. the bank lends someone 50 btc. so now i having 100 in the bank and someone is having 50 of my btc. 100+50 = 150.

as long as all the btc is not needed at once it should be relatively safe.

[Fizzgig]

Bitcoin is a digital commodity which is designed to have the real world monetary features of gold. Just like gold, derivatives of bitcoin will come forward (such as Mtgox credit, online wallets, etc). The derivatives are what can exceed the base bitcoin supply, not bitcoins themselves. If you study the evolution of gold as a form of money you will understand.

If you go back a few thousand years, gold existed with many different commodities which gained favor as a medium of exchange, however gold won out. Now come back to the present, Bitcoin exists in an environment in which it will have to compete with alternative cryptographic currencies to maintain dominance. The technological innovation that has come is a result of the brutal way in which money, the ultimate form of volunteerism, has been stripped from the people.

[DeathAndTaxes]

Easy fractional reserve DOESN'T require a central bank. 

Now most fractional reserve systems ALSO have a central bank. 

USD Fractional Reserve
Monetary base = money issued by central bank.  Variable can increase or decrease to any amount set by central bank.
Monetary Supply = total liquid assets (including demand deposits) at local banks.
The fractional reserve acts as a money multiplier.   
(Monetary base) * (money multiplier) = (Money Supply)

BTC Fractional Reserve
Monetary base = money issued by the blockchain.   Fixed at 21M and can never be changed (barring protocol change).
Monetary Supply = total liquid assets (including demand deposits) at local banks.
The fractional reserve acts as a money multiplier.   
(Monetary base = Fixed 21M) * (money multiplier) = (Money Supply)

If all Bitcoins were in fractional reserve banks and those banks had an effective reserve of 20% then the money multiplier would be 5.0 and thus the monetary supply would be 105M.  More realisticly say in some future all the fractional reserve bit-banks had an effective reserve of 33% and had in deposit 10% of monetary base.  The multiplier would be a mere 1.2.  The monetary supply would be effectively increased by ~20%.  The purchasing power of a Bitcoin would likewise be diluted 20%.

I think it is unlikely fractional reserve banks will ever be able to attract enough deposits to affect the monetary supply in any meaningful way but that doesn't make fractional reserve banking impossible.

[memvola]

I'm obviously missing something, what does "money supply" mean other than the total amount of Bitcoins in existance?

I see that others have already used the terms real and virtual BTC. The money supply (at least in the meaning used in the article) is the sum of both.

The illusion appears because of the fact that your money at the bank is not real Bitcoin, it is a promise. Just like gold certificates are not gold themselves. If they are traded as if they are gold (or BTC), then the result is analogous to having more of those in circulation. We are not used to this separation, because with the fiat money we use everyday, there is no real thing, at least not in the same sense.

There is an advantage of Bitcoin over gold though. Keeping your money yourself, and making real transfers is pretty easy. That's why derivatives are unlikely to considerably increase the money supply.

[lonelyminer (Peter Šurda)]

I tried to explain it several times, apparently unsuccessfully.

FRB means that someone (let's call them "bank" for simplicity) issues debt instruments in nominal value larger than the reserves they have.

Money supply is defined in different ways, but the best one is the total nominal value of whatever is used as a medium of exchange.

In order for FRB to affect money supply, the debt instruments issued must be accepted as a medium of exchange (for simplicity, we'll assume this occurs at par). Having zero maturity (being redeemable on request) is an insufficient condition.

The reason why debt instruments are sometimes accepted as a medium of exchange instead of whatever is used for reserves is that they decrease transaction costs. For example, a paper bank note might be easier to carry around than a gold coin, or it might be easier to transfer the balance electronically than to exchange gold physically. With a monetary system based on physical commodity such as gold, or central banking (central bank reserves plus currency serving as reserves), this reduction of transaction cost is an inherent aspect of the system.

With Bitcoin, the debt instruments issued against Bitcoin reserves do not, in general, reduce transaction costs. Therefore, they are, in general, not accepted instead of Bitcoin. Therefore, they are not a part of the money supply. It is hypothetically possible that an unusual type of debt instrument decreases transaction costs, for example Ripple and OpenTransactions. I'm not sure about the latter one, but the former one has the potential to increase the money supply (of Bitcoin).

If you think it's too complicated, think about apples and oranges. If I want to buy an apple, and the seller persuades me to accept an orange instead, for me, these two act as substitutes, i.e. I can eat either an apple or orange to achieve the same purpose. However, because people do not, in general, accept oranges instead of apples, this seller persuading me to accept an orange instead of an apple does not mean that oranges affect the supply of apples.

DeathAndTaxes disagrees.

[lonelyminer (Peter Šurda)]

I know DeathAndTaxes has me on ignore, but just for the others:

Monetary Supply = total liquid assets (including demand deposits) at local banks.

"Bitcoin demand deposits" are not liquid, almost noone accepts them instead of real Bitcoins. In a lot of cases, transferring them is not even technically implemented. What they rather have is zero maturity: you can redeem them into real Bitcoins, which you then transfer to some other Bitcoin user. Zero maturity, however is an inadequate condition for a debt instrument to be included in the money supply.

[djoot]

I make a 100 bitcoin deposit at a bank.

The bank loans out 90 of my bitcoins (with my permission, paying me interest, and my promise that I will not withdraw my deposit for a year).

There you have FRB with bitcoin.

This is not a demand deposit. It's basically a bond. FRB is when the bank has obligations to pay right now, on demand an amount of money it has invested elsewhere. In case there is a run on the bank they would have to borrow money or liquidate investments. If it can't do this it would have to default on the promises to pay. This is a good reason to not ever accept demand deposits at par value on a free market.

With fiat money and a governmental guarantee that your deposit is safe, you might accept demand deposits at par, since the government can always print the money to cover your deposit. Bitcoins, however, can not be printed, and only a fool would accept demand deposits at a FRB at par value.

[kjj]

The purpose of a central bank is to make bank runs effectively impossible.

Bank runs were a way to keep banks honest.  If any day arrived when they were asked to redeem more deposits than they actually had available, the bank would fail.  The threat of that should be enough to prevent it from ever being necessary, but in practice not so much.  Since restraint seemed to be impossible they cooked up a scheme where all money was virtual, so that a central bank (owned by the other banks) could literally create money out of thin air in any quantity needed to prevent a bank run.  People think that FDIC does this job, but it doesn't.  FDIC is a fig leaf to hide other banking sins.

They got the politicians on board by giving them the power to spend whatever they wanted by automatically creating loans in any quantity the politicians desired.

Fractional reserve is possible in the bitcoin world, but a central bank capable of conjuring coins is not.  Deposit insurance may be possible, but probably would not be practical.  Banking in bitcoin will probably always be very nearly 100% depositor risk, which means that a bank offering high interest to depositors will automatically be highly suspect.  And since the bankers will not be able to offer unlimited spending to the politicians to buy laws favorable to them, fractional reserve will very likely be seen as outright fraud.

[cbeast]

Fractional reserve is possible in the bitcoin world, but a central bank capable of conjuring coins is not.  Deposit insurance may be possible, but probably would not be practical.  Banking in bitcoin will probably always be very nearly 100% depositor risk, which means that a bank offering high interest to depositors will automatically be highly suspect.  And since the bankers will not be able to offer unlimited spending to the politicians to buy laws favorable to them, fractional reserve will very likely be seen as outright fraud.

[bold emphasis added]

This is an emergent property of this new paradigm. Modern monetary alchemists have produced arcane financial concoctions far beyond the banking system's quaint 10:1 FRB trick. Leveraging in big business is orders of magnitude beyond what exists at you local mortgage lender. Bitcoin can indeed be used to create new financial vehicles every bit as powerful and probably much more so than anything existing today. OpenTransactions is an example of what is only the beginning of powerful, yet transparent financing.

[Kilmyos]

I understand now. I simply misunderstood the quote thinking somehow it was stating bitcoin could be counterfeited. I guess I was thinking too hard

[DeathAndTaxes]

I tried to explain it several times, apparently unsuccessfully.

No you were sucessful some people just disagree with you.  It happens.

Money supply is defined in different ways, but the best one is the total nominal value of whatever is used as a medium of exchange.

The best one according to you.  However the presence of more money has an effect on prices even if it isn't DIRECTLY used in a medium of exchange.

For example I have $2K in my checking account.  I purchase a $1K 6 month CD.  Did the money supply shrink?   Well according to the Federal Reserve the M0 has shrunk but the M2 remains the same.  The $2K was never part of the M0.

M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.
M1: The total of all physical currency part of bank reserves + the amount in demand accounts ("checking" or "current" accounts).
M2: M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).

In order for FRB to affect money supply, the debt instruments issued must be accepted as a medium of exchange (for simplicity, we'll assume this occurs at par). Having zero maturity (being redeemable on request) is an insufficient condition.

This is your belief but not one universally shared by economists.  It is a conclusion you leaped to without evidence.  

In the example above the Fed includes my $1K CD in the M2.  By your definition a CD wouldn't be included in the money supply.  It is hardly used a medium for exchange.  Why? Because even indirectly it influences my buying habits.    Say hypothetically the bank was offering 20% interest on my CD and it was a $100K CD not a $1K.  Every month I am getting about $1600 "richer" (in nominal terms).  Now while I may not have access to that $1600 my newfound richness may cause me to spend MORE of my other money.  

In other words the rising value of my M2 savings has an effect on how likely I am going to spend my M0/M1 money.  In macro-economic view is the aggregate goods and services is growing slower and millions of people are also experiencing the same "richness" they are all more likely to spend (or spend a greater % of their available cash) and that will lead to higher prices (and reducing in buying power of 1 USD).  

So the Fed includes CD in M2 calculation.  CD (non demand deposits) increase the money supply.

To the OP:  
The TL/DR version is money doesn't HAVE to be spent to affect the money supply.  Everyday MOST money in the money supply isn't spent but even when not spent it influences buying/pricing decisions and thus is important to consider in macro economics.  For example say you like Dr. Crypto soda and consider 1 BTC to be a good value.  Not lets also pretend exchanges don't exist so if you want to drink Dr. Crypto soda you need to spend BTC.  You consider 1 BTC to be fair.  Now if the price rises to 1.2 BTC you may not be as likely to buy it however lets say your wealth (in BTC) also increased by 20% and your paycheck (in BTC) increased by 20%.  Now the 20% rise in price is less likely to affect your consumption.  Even if you only had 100 BTC in your wallet the fact that you have a 50K BTC savings bond (earning interest and increasing your wealth) in the First International Bank of Bitcoin will influence your willingess to accept higher prices.  Likewise if the bank failed and you lost the 50K (money multiplier collapse) you may not accept the 1.2 BTC price as fair.  You might not even drink as much Dr. Crypto even at 1 BTC.

To Loney Miner: 
Even if your defintion WAS correct (which it isn't) then fractional reserve banking would STILL affect the Bitcoin money supply.  Take a Mt. Gox code.  Say you wanted to sell a video card for 100 BTC.  Someone says I don't have 100 BTC but I have this Mt. Gox code for 100 BTC.  Would you not take it?  Of course you would.  Not Mt. Gox (hopefully) isn't engaged in fractional reserve banking so there is no multiplier effect but lets say they did.  Would you take it at par?  Most people would but even if you wouldn't would you take it for 80 bitcents on the Bitcoin?  60 bitcents on the Bitcoin?  50 bitcents on the Bitcoin?   

Even if you were so cautious you would only accept 100 BTC or 200 BTC Mt Gox code it affects the money supply (if Mt. Gox engaged in fractional banking).  The amount you discount it (well aggregated discounting of entire ecnomy) would REDUCE the money multiplier effect but just because it is discounted doesn't mean it magically becomes "non-money".

DeathAndTaxes disagrees.

Of course I do.

Well me, most economist, and US Federal Reserve.

[BurtW]

This again?  Here are 8 pages of this point (how to define the term "money supply") being discussed - by many of the same people:  https://bitcointalk.org/index.php?topic=51899.0

OP I know you did not realize what a can of worms you were opening with your simple questions but if you really are interested you can read the above thread as it discusses this in excruciating detail.

Oh, and PLEASE lock this thread.  If you do not they will go at it for another 8 pages - just kidding.

Isn't there a joke in here somewhere?  How many economists does it take to screw in a lightbulb?  No one knows since no one has ever gotten two economists to agree to anything

Or something like that

[lonelyminer (Peter Šurda)]

DeathAndTaxes,

in the previous thread, I provided about 7 quotes which explain that the reason why demand deposits are considered a part of the money supply is that they act as money substitutes. You ignored that and claimed that I did not provide any references. It is your position that is not shared by economists. In fact, it leads to absurd conclusions and invalidates the concepts of money supply and money velocity.

The reason why M2 is sometimes considered as a part of the money supply even if it is not a money substitute is that it can be converted into demand deposits (M1) at zero maturity, which increases M1. But this is only possible if M1 is inflatable. With Bitcoin, this is currently not possible, since M1 is only Bitcoin itself, there are no Bitcoin substitutes (and, possibly, never will be).

People in general do not take a Mt.Gox code instead of Bitcoin, if not for anything else than because it's technologically incompatible with it. More generally, it does not decrease transaction costs, and even if was able to match the transaction costs, there is no particular reason to accept it at a different rate than the reserve ratio of hypothetical FRB-Mt. Gox.

Unlike gold or fiat money base (central bank reserves + cash), Bitcoin can have all kinds of forms, so Bitcoin debt instruments need to compete with these forms of Bitcoin. This gives Bitcoin an advantage in the transaction costs, therefore Bitcoin debt instruments will possibly never act as Bitcoin substitutes. At least not in the typical forms, there is still a potential for things like Ripple.

I already spent so much time explaining this, so I'm not going to repeat again because you'll ignore it anyway. You parrot what you read, but do not understand it.

[jago25_98]

What about other precious metals, how does Gold corrolate to other precious metals?