But I am positing the problems a finite currency such as bitcoin and it’s associated blockchain technology will have with many common currency functions. I agree that there are problems that are glossed over by the boosters of Bitcoin type currencies. That is why I posted my thoughts on such a problem. I was wondering if there are some current solutions. Or some ideas going forward.
As it stands I don’t think there are solutions. Bitcoin denies the inflation of the money supply. But what solutions are there in such a system for loans?
I am pondering some fuzzy concepts of connecting/converting a Bitcoin loan value into a pool of somewhat stable commodities? Gold being one of those commodities? Loaned Bitcoin goes into and out of that commodity pool? It gets very complicated and less stable than the basic Bitcoin concept.
I have no idea what goes through your mind when you read that article.
I TA’d the 4000-level course entitled “Commercial Bank Management” and the 3000-level course “Money and Banking” in a top 100 ranked, flagship state university in 1991-1993. I haven’t been working in the field since then, but I’m fairly certain I’m solid on the basics of how banking works in the US and globally (my Masters thesis was on the problems of the Japanese banking sector, that were not apparent to 90%+ of professional observers at the time, fortunately not my advisor).
Banks are not going to be Bitcoin depositories any more than they were gold or silver depositories in the 19th century. A bank is not a vault service for gold, silver or currency now and hasn’t been for hundreds of years. They aren’t going to be Cryptocurrency depositories either. That’s not banking.
I am not trying to dissect the fractional reserve banking system. I am asking how Bitcoin or such a finite currency can handle the loan system.
And in fact the fractional reserve system does inflate the money supply. You can loan out more money than exists. It goes into the economy and generates activity that is not yet earned or paid for. On top of that it extracts interest that needs to be paid.
I give up.
Copied from the article I posted the link to.
“Historically, the required reserve ratio on non-transaction accounts (such as CDs) is zero, while the requirement on transaction deposits (e.g., checking accounts) is 10 percent. Following recent efforts to stimulate economic growth, however, the Fed has reduced the reserve requirements to zero for transaction accounts as well.”
So a bank can loan out $1000 dollars on an actual $100 dollars it has. Or even more.
A bank can create $900 dollars and loan it to someone, if it has $100 dollars in it’s deposits.
Another explanation of how fractional reserve banking expands the money supply. And some of the associated problems.
I agree. At this point banks don’t want a lot to do with Bitcoin, except behind the scenes as some may be trading it for their own purposes. It is still far too wild and on most governments bad list of things. But what if it was THE currency? How can it work in just one instance of something such as loans? You have taken courses related to banking. Can you suppose a way it might work, or cannot work?
Right. And the bank lends out 0.9 of it. Let me try to explain this with names:
Aaron deposits 1000 BTC.
The bank lends 900 to Bill.
Carrie deposits 900 BTC.
The bank lends 810 to Dave.
No one bitcoin, anywhere, is replicated. Every one of the 1000 BTC is accounted for in one place in the blockchain; Dave has 810, the bank has 190.
But on paper, people have a total of more than 1000. That is what fractional reserve banking is for. It allows a fixed amount of money to be multiplied in circulation. It would work exactly the same if all money was one dollar bills.
It is a near universal truth among dating women in their 30s-60s that Bitcoin guy is to be avoided at all costs.
I have no doubt that you did well in the course. But I am curious how much of the course was devoted to some of the problems inherent in banking systems. Not just internal to the systems but external to the complex economic system as a whole. A course cannot be too broad. That in no way means it is not good. It has a goal. It may be excellent in it’s goal to further you in a career in banking. But to investigate more complex and further removed economic impacts of banking might take several other less directly related courses. Ones that might actually detract from pursuing a career in banking.
How can a bitcoin be loaned? Based on my understanding of how bitcoin works, I don’t understand how exactly they can be loaned. Sold, given away, or stolen I can make sense of, but I’m not sure how exactly loaning one would work.
Exactly the same way I can loan you twenty bucks; I hand you $20, and you sign something saying that you owe me twenty bucks. I can lend you a bitcoin by transferring it to you, and you sign a thing saying you owe me a bitcoin.
Kedikat you are quite right that the bitcoin system will not track fractional reserve banking. That however does not mean it will not work with bitcoin.
Stop me if you know this stuff but I don’t know what you don’t know. Money is what is called a “fungible”. if I lend you my cat, you are entitled to get your cat back. You could even go to court for an order that I give you back your specific cat. If you lend me a single $100 bill in cash it is now my money - you have a debt. Debts are a form of property. You are entitled to $100 back but you are not entitled to the specific bill you gave me. Even if you went to court, the court will not give you an order that I give you your original $100 note back, as long as I offer you $100 in cash.
I’m not sure whether it has ever been tested in court but I would be pretty certain that a court would treat bitcoin the same.
The next thing you need to understand is that banks do not create money as such. What they do is create situations where they owe more than they have on hand in cash.
So to continue with RickJay’s example:
There is a bank and:
-
Aaron deposits 1000 BTC. The bank now has Aaron’s bitcoin. They are not Aaron’s bitcoin any more. The position now is:
- Aaron owns a debt in his favour of 1000BTC
- The bank has 1000BTC
-
The bank lends 900 to Bill. The position now is:
- Aaron owns a debt from the bank in his favour of 1000 BTC
- The bank has 100 BTC and owns a debt from Bill in its favour of 900 BTC
- Bill owns 900 BTC
-
Carrie deposits 900 BTC. The position now is:
- Aaron owns a debt from the bank in his favour of 1000 BTC
- The bank has 1000 BTC and owns a debt from Bill in its favour of 900 BTC
- Carrie owns a debt from the bank in her favour of 900 BTC
-
The bank lends 810 to Dave. The position now is:
- Aaron owns a debt from the bank in his favour of 1000 BTC
- The bank owns 190 BTC and owns debts from Bill and Dave in its favour of totalling 1710 BTC in total
- Carrie owns a debt from the bank in her favour of 900 BTC
You will that at every stage, the books balance between bitcoins and debts. The system allows “extra” money to circulate in the sense that at any given time Aaron and Carrie can say they “have” 1900 BTC (in total) but of course they don’t - they are owed that amount - while at the same time Bill and Dave can say they have 1710 BTC - which they do - but they also owe the same amount.
And the bank can say it’s books are balanced, even though if Aaron and Carrie were to demand their money bank instantly, the bank couldn’t pay until it called in its loans from Dave and Bill.
Does that help?
For the sake of this situation let us say the bank has a wallet.
Aaron deposits all of his 1000 BTC in his savings account. So the Bitcoin blockchain records Aaron as buying a bank account worth 1000 BTC.
Now the bank has 1000 BTC in it’s wallet. According to the blockchain Aaron now has 0 ( zero ) BTC. He just spent it all buying a bank account. The bank and Aaron have to have some accounting outside the BTC blockchain that legally states that when Aaron wants his BTC back, they have to give it to him.
But. Bill borrows 900 BTC from the bank. Okay the bank transfers 900 BTC to Bill’s wallet. Now the bank has 100 BTC, Aaron has 0 BTC and Bill has 900 BTC.
Bill buys a car for 900 BTC. The car dealer now has 900 BTC in it’s wallet. Bill has 0 BTC in his wallet. The bank has 100 BTC in it’s wallet. Aaron has 0 in his wallet.
Aaron has to pay the rent. It is 500 BTC. He goes to the bank to withdraw 500 BTC from his account.
The bank has 100 BTC in it’s wallet. Where does the bank get another 400 BTC from to give Aaron his 500 BTC?
At this point all of the finite Bitcoin has been mined.
Aaron owes 500 BTC in rent. Bill has a new car, but 0 BTC. He will have to pay back 900 BTC and interest. The car dealer has 900 BTC. Will it transact 400 BTC back to a bank so the bank can deliver on it’s obligations? I doubt it, unless a loan with interest is in order. But then it starts again with added interest…
From other depositors. That’s how fractional reserve banking works, and it’s why a bank run can destroy a bank. That used to be a thing that happened a lot, actually.
In modern times, banks are generally so big there’s little chance of a really huge bank run, and banks can temporarily borrow additional money from the central bank to cover unusually substantial withdrawals.
Was writing my post as you were writing yours. I will compare 
Sorry I deleted my last post because you hadn’t gone quite as far badly wrong as I thought you had.
Technically, the situation you have outlined is one in which the bank is insolvent. The bank goes broke. Its creditors are sadly out of luck. Exactly the same situation could arise with dollars.
In reality, the bank simply makes sure it never reaches this position, by always making sure that has enough on hand to cover likely withdrawals. This is exactly the same whether it is bitcoin or USD.
The blockchain cannot say both the bank and Aaron have those 1000 BTC. That would create 1000 duplicate BTC not allowed.
I noted that. It could be a separate contract in another blockchain scheme. But i do not know that the current BTC blockchain encompasses side contracts. I think not.
Correct. Aaron no longer has the bitcoin. This is the same with dollars or bitcoin.
It does not. It doesn’t matter. It is possible for people to have contracts (such as loans) about bitcoin that are not recorded by the blockchain.