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

[johnyj]

This topic just get hot recently

After several Chinese exchanges opened the option to do leveraged trading, many doubted that they can essentially create many bitcoins out of thin air based on fractional reserve principal, then they could use those coins to short the market and squeeze out many traders to get real coins in their hand

Of course, they can also create fictional fiat money to push up the price by many folds using the same practice, most possibly MTGOX has already done that and that is the main reason the exchange rate fluctuated so dramatically before

So what is your opinion about this? Even if you auditing an exchange and make sure their cold storage contains 50K coins, it does not stop them from creating 500K coins sell pressure using a fractional reserve ratio of 10%

[knight22]

I wouldn't touch these exchanges even with a ten foot pole. Too many manipulation can occur in these.

[webbrowser]

I don't like the idea.

As long as the exchange is not large enough to move the market, and bitcoins and fiat can flow freely in and out of the exchange, would it be profitable for the exchange to create imaginary buy/sell pressure?

[moriartybitcoin]

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

[chennan]

I don't like the idea.

As long as the exchange is not large enough to move the market, and bitcoins and fiat can flow freely in and out of the exchange, would it be profitable for the exchange to create imaginary buy/sell pressure?

Yes, when the price is high, the exchange sells leveraged coins to the market. When the price is low, they buy back or still sell leveraged coins. They makes lot of profit from trading in terms of fiat.

[jonald_fyookball]

only if fully disclosed to site users.  otherwise it could mean insolvency.

[glendall]

I think it's a terrible idea. If I wanted fractional reserve instability than I'd just buy USD, not bitcoin.

The exchanges are free to do whatever though, and people should vote with their wallets. But they must be responsible enough to at least tell everyone how they operate. 

[johnyj]

I wouldn't touch these exchanges even with a ten foot pole. Too many manipulation can occur in these.

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

If one of the large Chinese exchanges are taking a market share of 15%, they can essentially sell millions of bitcoins on the whole market and push the price into single digits and crash people's confidence in bitcoin, and people can not do anything about it: The only thing you can do is to withdraw coins from the platform thus they will have a bitcoin bank run, but as most of the people on Chinese exchanges are speculators, I doubt they even want their bitcoin back if the price dropped to that low   Besides, many people still don't want to withdraw bitcoin since it is too easy for them to lose it without proper IT knowledge, they regard the exchanges like a stock exchange, they trade there but never touch a bitcoin/stock

The main problem is that currently there is no regulation for bitcoin exchanges anywhere, and maybe there will never be


On further thoughts, another exchange might use the same trick to create fictional fiat money to buy lots of coins on their platform, and let the arbitrager to drain the bitcoins from the other exchange to make a bitcoin bank run for them... We need more exchanges

[frankenmint]

I wouldn't touch these exchanges even with a ten foot pole. Too many manipulation can occur in these.

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

If one of the large Chinese exchanges are taking a market share of 15%, they can essentially sell millions of bitcoins on the whole market and push the price into single digits and crash people's confidence in bitcoin, and people can not do anything about it: The only thing you can do is to withdraw coins from the platform thus they will have a bitcoin bank run, but as most of the people on Chinese exchanges are speculators, I doubt they even want their bitcoin back if the price dropped to that low   Besides, many people still don't want to withdraw bitcoin since it is too easy for them to lose it without proper IT knowledge, they regard the exchanges like a stock exchange, they trade there but never touch a bitcoin/stock

The main problem is that currently there is no regulation for bitcoin exchanges anywhere, and maybe there will never be


On further thoughts, another exchange might use the same trick to create fictional fiat money to buy lots of coins on their platform, and let the arbitrager to drain the bitcoins from the other exchange to make a bitcoin bank run for them... We need more exchanges

buyers and sellers create the volatility not the exchange in and of itself.  FWIW why is no regulation a problem - regulation doesn't solve the faults of fraud and incompetency that we see in the existing banking systems  - we need decentralized exchanges with a mechanism to use them in a centralized "liquid" manner - the ability to take 5000 usd and use it efficiently across X number of exchanges with just one account to be able to either buy 5000 worth of BTC or sell 5000 worth of BTC across them all.

[Nagle]

So what is your opinion about this? Even if you auditing an exchange and make sure thei cold storage contains 50K coins, it does not stop them from creating 500K coins sell pressure using a fractional reserve ratio of 10%

It's a criminal enterprise.

[johnyj]

So what is your opinion about this? Even if you auditing an exchange and make sure their cold storage contains 50K coins, it does not stop them from creating 500K coins sell pressure using a fractional reserve ratio of 10%

It's a criminal enterprise.

Same as you claim banks are criminal enterprise, it does not stop them from using FRB and creating financial crisis

[johnyj]

I wouldn't touch these exchanges even with a ten foot pole. Too many manipulation can occur in these.

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

If one of the large Chinese exchanges are taking a market share of 15%, they can essentially sell millions of bitcoins on the whole market and push the price into single digits and crash people's confidence in bitcoin, and people can not do anything about it: The only thing you can do is to withdraw coins from the platform thus they will have a bitcoin bank run, but as most of the people on Chinese exchanges are speculators, I doubt they even want their bitcoin back if the price dropped to that low   Besides, many people still don't want to withdraw bitcoin since it is too easy for them to lose it without proper IT knowledge, they regard the exchanges like a stock exchange, they trade there but never touch a bitcoin/stock

The main problem is that currently there is no regulation for bitcoin exchanges anywhere, and maybe there will never be


On further thoughts, another exchange might use the same trick to create fictional fiat money to buy lots of coins on their platform, and let the arbitrager to drain the bitcoins from the other exchange to make a bitcoin bank run for them... We need more exchanges

buyers and sellers create the volatility not the exchange in and of itself.  FWIW why is no regulation a problem - regulation doesn't solve the faults of fraud and incompetency that we see in the existing banking systems  - we need decentralized exchanges with a mechanism to use them in a centralized "liquid" manner - the ability to take 5000 usd and use it efficiently across X number of exchanges with just one account to be able to either buy 5000 worth of BTC or sell 5000 worth of BTC across them all.

Actually I don't really know how stock exchanges are regulated. For example, could a stock exchange create fictive stocks and short them to crash the market? I think they can not, there might be some kind of third party auditor holding all their stocks so that they could not create stocks out of thin air by using FRB, they can only request deposit or withdraw of equities from that auditor upon customer request

In bitcoin's case, the exchange are holding both fiat money and bitcoin, no one knows how much fiat/coins they indeed have, unless there is a panic withdraw, which is very seldom

[medicine]

An exchange going for transparency could perform and display real time btc holdings data to its users.  Or at least a daily audit of crypto holdings.  This wouldn't stop other exchanges from practicing fractional reserve but it would give us a choice when we are choosing which exchange to use.

[Lethn]

I wouldn't touch these exchanges even with a ten foot pole. Too many manipulation can occur in these.

+1

Fractional reserve banking is a scam, all financial exchanges or places of businesses should operate purely on a 1:1 ratio of whatever they hold and what is represented digitally.

[johnyj]

An exchange going for transparency could perform and display real time btc holdings data to its users.  Or at least a daily audit of crypto holdings.  This wouldn't stop other exchanges from practicing fractional reserve but it would give us a choice when we are choosing which exchange to use.

Yes that can be done, but it does not stop even this specific exchange from practicing FRB

For example, an exchange through third party auditor shows that they have a daily holding of 50K+ coins in their cold wallet address. Customers can be sure that their coins are safe

However, on exchange's platform, everyone's account balance is just a number, only when you withdraw, they need to take bitcoins out from that cold storage, in the daily audit, they always have 50K+ coins in their cold wallet (suppose the amount of  customer deposit and withdraw are almost equal)

Now since all these 50K+ coins are just sitting there collecting dust, the exchange could loan out 80% of those coins to themselves (they can not loan out to other exchanges, that will affect their cold storage balance). That is just an accounting record on their own book. Now suddenly they have 40K coins at hand ... to sell

So they start to dump all these coins on the exchange and drive the price much lower, and will cause more panic sell and they collect real coins during the process. The interesting thing is, customers can see that the amount of coins in their cold storage even increased, but most of the customer won't withdraw bitcoin, they might even want to sell the coins and withdraw fiat money, this will create a liquid squeeze of fiat money and very quickly the fiat money on exchange will run out, and the price crash hard

Of course then smart money will run into this exchange to buy coins and withdraw, the withdraw will directly affect exchange's cold storage thus they have to buy back coins to reduce the size of their loan, but if the price were so low and many people's confidence of bitcoin get hurt, it will take a long time to recover

The best solution from a user perspective is to withdraw bitcoins as soon as you bought it, never leave a satoshi on the exchange, but I think many of them just left their coins/money on the exchange due to old habit in stock/commodity trading

[medicine]

An exchange going for transparency could perform and display real time btc holdings data to its users.  Or at least a daily audit of crypto holdings.  This wouldn't stop other exchanges from practicing fractional reserve but it would give us a choice when we are choosing which exchange to use.

Yes that can be done, but it does not stop even this specific exchange from practicing FRB

For example, an exchange through third party auditor shows that they have a daily holding of 50K+ coins in their cold wallet address. Customers can be sure that their coins are safe

However, on exchange's platform, everyone's account balance is just a number, only when you withdraw, they need to take bitcoins out from that cold storage, in the daily audit, they always have 50K+ coins in their cold wallet (suppose the amount of  customer deposit and withdraw are almost equal)

Now since all these 50K+ coins are just sitting there collecting dust, the exchange could loan out 80% of those coins to themselves (they can not loan out to other exchanges, that will affect their cold storage balance). That is just an accounting record on their own book. Now suddenly they have 40K coins at hand ... to sell

So they start to dump all these coins on the exchange and drive the price much lower, and will cause more panic sell and they collect real coins during the process. The interesting thing is, customers can see that the amount of coins in their cold storage even increased, but most of the customer won't withdraw bitcoin, they might even want to sell the coins and withdraw fiat money, this will create a liquid squeeze of fiat money and very quickly the fiat money on exchange will run out, and the price crash hard

Of course then smart money will run into this exchange to buy coins and withdraw, the withdraw will directly affect exchange's cold storage thus they have to buy back coins to reduce the size of their loan, but if the price were so low and many people's confidence of bitcoin get hurt, it will take a long time to recover

The best solution from a user perspective is to withdraw bitcoins as soon as you bought it, never leave a satoshi on the exchange, but I think many of them just left their coins/money on the exchange due to old habit in stock/commodity trading

I'm no expert, but I will disagree this time. 

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?

[blatchcorn]

I wouldn't touch these exchanges even with a ten foot pole. Too many manipulation can occur in these.

Agreed completely.  What is concerning is that it is very easy to implement a proof of reserves feature; why aren't all exchanges doing this?

[SomethingElse]

It's big trouble. It's just a matter of time before the exchange owner blows the money on alcohol and girls. This is a real problem with high rollers in china. I try not to use an exchange and when I do I try to avoid china but when I can't I get my money back as soon as possible.

[CharHill]

This topic just get hot recently

After several Chinese exchanges opened the option to do leveraged trading, many doubted that they can essentially create many bitcoins out of thin air based on fractional reserve principal, then they could use those coins to short the market and squeeze out many traders to get real coins in their hand

Of course, they can also create fictional fiat money to push up the price by many folds using the same practice, most possibly MTGOX has already done that and that is the main reason the exchange rate fluctuated so dramatically before

So what is your opinion about this? Even if you auditing an exchange and make sure their cold storage contains 50K coins, it does not stop them from creating 500K coins sell pressure using a fractional reserve ratio of 10%

I think that is real. Look at the fiats market, USA's credit, and other economics global credits with fictional fiats. After that btc fictional credit story look like a joke.

[Mobius]

I wouldn't touch these exchanges even with a ten foot pole. Too many manipulation can occur in these.

+1

Fractional reserve banking is a scam, all financial exchanges or places of businesses should operate purely on a 1:1 ratio of whatever they hold and what is represented digitally.

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.