What is your idea about fractional reserve practice at bitcoin exchanges?

[pand70]

They could do what you describe in your OP without leveraged trading.
Leverage is a tool for investors *cough* to lose their money faster *cough* and not a way for exchanges to rig the system.

If an exchange is untrustworthy can just run away with your money. They don't need to introduce more trading options for that to happen.

[johnyj]

They should have third party software performing the Merkle construction once a day lets say.  A second "third party program" could verify individuals account holdings (crypto only mind you) by checking hash values.  This program would be encrypted and stored on exchange servers by a third party.  Then individuals could be assigned personal private keys to decrypt and run the verification software as they please.  The private keys could be stored locally on customer devices.

Encrypting and MACing the verification software would ensure the exchange themselves could not alter this software.  As long as enough users verified their holdings periodically they might be able to prove the exchange was not holding less coins than that declared by the daily merkle tree.

This is not an audit of course, more like an inventory check.  I am I missing something?

When you deposit 10 bitcoins into an exchange, they move those coins into their cold storage, and they publish that address, so that you can check that they indeed have your bitcoin in a secure place, this is all fine

And then you open the trading platform, place an order of selling 10 coins and receive 5K dollar. On your account, you will see that you now have 0 bitcoin and $5K, but if you look at that address they provided you, you will see that those bitcoins are still there

So what you see on the trading platform is exactly like what you see in your bank account, those are just numbers in a database, they changes upon your trading activity, but the real fiat/bitcoin never moves until you do a deposit/withdraw

Actually the trading activity on platform always carry out in a database, never touch the real money. Suppose that the exchange added an account into the database, which has 30K bitcoins, then this account could immediately start to sell those coins on the exchange, without physically have 30K coins at all

The key for auditing is this database. By manipulating this database, an exchange who has only a little coin could create huge amount of  coin transaction volume by creating fictional coins in their database. That is the reason some of the Chinese exchanges suddenly had that huge volume during last year

I saw BTC china just provided open letter to let third party to audit that database, that is a great step forward, but all the other exchanges provide no such transparency so far

[seriouscoin]

I saw BTC china just provided open letter to let third party to audit that database, that is a great step forward, but all the other exchanges provide no such transparency so far

I've been saying this and no1 listened.

Most of the westerners dont understand crap about Chinese culture. I'm not discriminating but its the fact that when it comes to money, Chinese are all about cheating.

Look at Chinese stock market and all the scandals from "investment brokers"

Regulation in China  means " corruption". Most Chinese stock traders are actually low income citizens (factory workers, minimum wage labourer), they treat stocks as gambling.


I'm shocked and disappointed to see NO ONE asked Houbi , OKcoin at whatever conferences they participated about proof of transparency. Its safe to assume they're all thieves. In China, thats 90% the case.

[johnyj]

I saw BTC china just provided open letter to let third party to audit that database, that is a great step forward, but all the other exchanges provide no such transparency so far

I've been saying this and no1 listened.

Most of the westerners dont understand crap about Chinese culture. I'm not discriminating but its the fact that when it comes to money, Chinese are all about cheating.

Look at Chinese stock market and all the scandals from "investment brokers"

Regulation in China  means " corruption". Most Chinese stock traders are actually low income citizens (factory workers, minimum wage labourer), they treat stocks as gambling.


I'm shocked and disappointed to see NO ONE asked Houbi , OKcoin at whatever conferences they participated about proof of transparency. Its safe to assume they're all thieves. In China, thats 90% the case.

Well, bitstamp and btc-e also don't provide such transparency, and MTGOX used to be the worst

It is a fact, since trading data and real money are separated on the exchange, there is a lot of room to play around, just like a bank do, you never know what is going on behind the scene until one day that bank suddenly claim a liquidity crisis -- their vault has been emptied since long ago, all the numbers on their customers account are just virtual

[evanito]

Fractional reserve is almost necessary for exchanges to run without having massive amounts of principal.

[Nagle]

I would disagree that traditional fractional reserve banking is a scam.

What happens in a traditional fractional reserve system is that someone deposits $100 in a bank, so the bank would have $100 in assets (the $100 bill) and $100 in liabilities (the deposit to the account holder). What the bank will do with part of the $100 is they will lend it to a borrower. So now they will still have $100 in assets (now a $10 and $90 that is owed to them from the borrower) and $100 in liabilities (the same $100 deposit).

What is potentially happening with Chinese exchanges is they are taking a 1 BTC deposit, and spending some amount of it, say .1 BTC. In this example they have only .9 BTC in assets (they spend the .1 on themselves) but 1 BTC is liabilities. Hopefully you can see how different these two scenarios are.
[/quote]

Right. Trouble can occur if a bank has bad loans, which is what caused the last financial crisis. But there were real loans, and real houses behind them. What happened was that the value of those houses declined, and the people owning them stopped making payments.

Also, banks are heavily regulated, and in many countries backed up by deposit insurance. No US depositor lost money because the bank in which they had a deposit made bad loans. (Many bank depositors in Iceland did lose money. Look up "Icesave".)

Fractional reserve banking does not mean the bank gets to skim off most of the money.

[Nagle]

Fractional reserve is almost necessary for exchanges to run without having massive amounts of principal.

Well, duh. If you want to run a financial institution, you have to have some money.

[Leina]

Fractional reserve is ok if they are willing to cough up any loss due to taking risk on directional bet or even lending.

[spazzdla]

Have you ever heard of MT. Gox?  If not why don't you take a google they tried fractional reserves..  Did not go too well.  This is why we the gov should keep the F out.. alas they are pigs and will attempt to countrol everything to give the other pigs at the top an advantage.  Lucky for us most of them cannot create a txt file.

[spazzdla]

Fractional reserve is ok if they are willing to cough up any loss due to taking risk on directional bet or even lending.

I 100% disagree.  It is criminal our entire monteary system is criminal.

[Timo Y]

leverage and margin trading is destroying the Bitcoin price ...

What do you mean? By historical standards the price has been remarkably stable lately.

[Timo Y]

Of course not, but the question is what you can do to prevent them from creating too much volatility in market?

Educate people to avoid exchanges without proven reserves.

As long as people are aware that these exchanges are doing fractional reserve, the selling of fractional reserve bitcoins should not affect the bitcoin price. Real bitcoins will trade at a higher price than bitcoin IOUs.

[profitofthegods]

As long as they are very clear about what they are doing I don't have a problem with fractional reserve in principle, but if exchange owners are doing this to trade on their own exchange to the detriment of other users then surely people would just move to a different exchange?

If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.

[countryfree]

Those companies need to change their names. The idea of exchange cannot get along with the idea of fractional reserve, and this is just another reason not to leave any money at an exchange. Exchanges are made to trade, nothing else. I guess some people haven't learned anything from the MtGox fiasco.

[itsAj]

As long as they are very clear about what they are doing I don't have a problem with fractional reserve in principle, but if exchange owners are doing this to trade on their own exchange to the detriment of other users then surely people would just move to a different exchange?

If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.

What most exchanges that are likely operating on a fractional reserve are likely doing are spending their customer money. What a "real" fractional reserve exchange should do is use a portion of customer deposits to lend money to borrowers with the hope that, after interest payments and customer defaults, they will have a net profit on their loans.

[johnyj]

As long as they are very clear about what they are doing I don't have a problem with fractional reserve in principle, but if exchange owners are doing this to trade on their own exchange to the detriment of other users then surely people would just move to a different exchange?

If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.

What most exchanges that are likely operating on a fractional reserve are likely doing are spending their customer money. What a "real" fractional reserve exchange should do is use a portion of customer deposits to lend money to borrowers with the hope that, after interest payments and customer defaults, they will have a net profit on their loans.

Exchanges could lend these coins to themselves to short the market and trigger speculator's stop-loss. Since they have all the customer's coins on exchange, based on FRB principle they could borrow 90% of the coins, they could greatly crash the price to wipe out everyone, because no single big whale have the amount of capital to deal with all the coins on that exchange (Whale's money is only part of that pool)

For example, an exchange have 50k coins, and the amount of fiat money on exchange is 25 million, which maintains an exchange rate of $500. Then exchange borrow 45K coins to themselves and short the market, so all the fiat money on that exchange will be quickly drained, and the exchange rate could cut by half or more

Then the bargain hunters will rush in to deposit and buy coins to withdraw, money arrives after several days, exchanges will soon find out that they are facing a much larger withdraw than 5K coins (the rate under normal market condition), that will dramatically reduce their reserve and they have to buy back coins to reduce the withdraw pressure, then the price will recover quickly

Bitcoin world is wild west, no regulation on exchanges for what they can do

[johnyj]

Fractional reserve is ok if they are willing to cough up any loss due to taking risk on directional bet or even lending.

Great observation, as long as the banks/exchanges take their own loss, they can do whatever they want. But in reality, since customer's money is kidnapped by them, you have little option if they incur a huge loss and have nothing for you to withdraw

[itsAj]

As long as they are very clear about what they are doing I don't have a problem with fractional reserve in principle, but if exchange owners are doing this to trade on their own exchange to the detriment of other users then surely people would just move to a different exchange?

If a business wants to engage in fractional reserve practices then they need to offer something to their users in return for taking the risk of allowing the business to do this, like interest payments or something. That way people can choose - play it safe by using a service with no fractional reserve or take a risk on trusting a business with their coins in the hope of getting a share of the profits.

What most exchanges that are likely operating on a fractional reserve are likely doing are spending their customer money. What a "real" fractional reserve exchange should do is use a portion of customer deposits to lend money to borrowers with the hope that, after interest payments and customer defaults, they will have a net profit on their loans.

Exchanges could lend these coins to themselves to short the market and trigger speculator's stop-loss. Since they have all the customer's coins on exchange, based on FRB principle they could borrow 90% of the coins, they could greatly crash the price to wipe out everyone, because no single big whale have the amount of capital to deal with all the coins on that exchange (Whale's money is only part of that pool)

For example, an exchange have 50k coins, and the amount of fiat money on exchange is 25 million, which maintains an exchange rate of $500. Then exchange borrow 45K coins to themselves and short the market, so all the fiat money on that exchange will be quickly drained, and the exchange rate could cut by half or more

Then the bargain hunters will rush in to deposit and buy coins to withdraw, money arrives after several days, exchanges will soon find out that they are facing a much larger withdraw than 5K coins (the rate under normal market condition), that will dramatically reduce their reserve and they have to buy back coins to reduce the withdraw pressure, then the price will recover quickly

Bitcoin world is wild west, no regulation on exchanges for what they can do

I think this would be very risky. First of all if people started to withdraw their coins before the exchange can have an impact on the market then the exchange would be forced to repurchase the BTC at a potentially higher price. Also if the exchange were to crash the market in the way you described then their average price per BTC that they get from their borrowed BTC would likely be less then where the price would be once the market recovers as buyers would likely stop buying when the market is in a free-fall.

[Nagle]

Those companies need to change their names. The idea of exchange cannot get along with the idea of fractional reserve, and this is just another reason not to leave any money at an exchange. Exchanges are made to trade, nothing else. I guess some people haven't learned anything from the MtGox fiasco.

Right. A big problem with Bitcoin exchanges is that they act as broker, custodian of assets, transfer agent, and exchange. In the real world, those functions are separated.
The NYSE does not itself handle money or stocks. It's just an order-matching service.

[cooldgamer]

Fractional reserve exchanges are a terrible idea.  I think all of them should be required to have audits showing they have 100% of everybody's coins.  Leveraged trading is okay if everything is transparent like Bitfinex, but not just making BTC out of thin air.