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Perhaps one fundamental difference between the normal financial system and the more popular cryptocurrencies is in the way the money supply is managed. In the t

by lifty 8y ago

Perhaps one fundamental difference between the normal financial system and the more popular cryptocurrencies is in the way the money supply is managed. In the traditional system money becomes very cheap in specific periods, coincidentally or not right before major crisis events, which can act as gas on fire. In contrast, cryptocurrencies like Bitcoin or Ethereum have a more restrained issuance schedule, which some people or schools of economic thought argue that can lead to better emergent outcomes in the overall economy, avoid the boom and bust cycle. But of course, you can still build financial tricks based on them, but they might not have the same effect on the overall economy.

gmueckl 8y ago
No. I could go and found a bitcoin bank in which anyone can open an account. The catch? The bank runs a single wallet to back all accounts. The only promise made by the bank is that if you deposit X bitcoins, you'll get X bitcoins back when you request to withdraw them. I'll also allow you instant transfers between the accounts. They are off the blockchain, managed only in the bank's database, so these transactions can be arbitrarily fast. If the wallet accumulates enough bitcoins so that it exceeds the normal volume of deposits and withdrawals, I'll take the rest and put them to work. Maybe buy shares in companies or so. I'll keep the earnings of these investments. If I make a loss, I'll have to recover the loss somehow. That's the risk I take. At that point, I'd have created virtual bitcoins in the market. And who would be stopping me?
- lifty 8y ago
  That outcome is certainly possible. But even that scenario would be quite a departure from what we have now, where banks have almost no reserve requirement and they can create as much money as can be absorbed in the economy, which in turn is influenced mainly by central bank interest rate. Lending money entails risk and in a situation where the interest is set by a central bank and there are little to no reserve requirements, that risk gets shifted to the population that has to bailout the banks. In the scenario that you outlined, its probable that the reserve would much higher than the current 1-3%, which would lead to risk being more directly held by the bank making the loans and the depositors of that bank. And the argument goes that this might lead to more skin in the game and probably less reckless behaviour. Also, in such a system interest rates would be set by the market, based on the amounts of savings in the economy and the demand for loans.
  - deleted 8y ago
    [deleted]
  - lokedhs 8y ago
    I just don't see your reasoning. By what mechanism that is not provided today would the banks stop doing what they do today? What mechanism would control the exposure that banks take on?
    - lifty 8y ago
      Bitcoin and other cryptocurrencies are easier to store securely compared to bunches of cash, which would lead to less pressure to store them in a bank. Deposits would be incentivised using interest rates (set by the market). That and the banks not being able to create money would lead to them being more dependent on deposits; this in turn would put more pressure on banks that exhibit risky behaviour and favour banks that keep a healthy balance sheet. And why would there be more pressure to adjust risky behaviour? Because people would take their money out of banks that exhibit that behaviour, which would re-inforce behaviour that has the right ratio of risk/return. This does not happen now because banks don't need almost any deposits to make profit. This risk adjustment already happens in financial sectors that have skin in the game. For example, if a hedge fund looses money, sooner or later people will take their money out of it.
  - jhanschoo 8y ago
    > But even that scenario would be quite a departure from what we have now, where banks have almost no reserve requirement and they can create as much money as can be absorbed in the economy, which in turn is influenced mainly by central bank interest rate. I don't see how a Bitcoin bank as outlined above can be regulated to have a reserve requirement either. Arguably, this offers even less protection than a traditional bank, due to the inability of the public sphere to regulate it. And still, as long as a Bitcoin bank is perceived as sufficiently trustworthy based on past behavior, people would use it. Next, I don't share your view that interest rates being set by the market is a good thing. Economies were far more fragile and volatile back when they were backed by bullion. The vast majority of people who have income from labor comparable to their net worth prefer that their net worth not fluctuate so much that they may not consistently maintain their standard of living, and this is helped by a steady interest rate. A rational agent prefers this unless their net worth greatly eclipses their ability to obtain wealth from other forms of capital.
- DennisP 8y ago
  In today's world, a regulated exchange is prevented by law and auditors from doing that. Banks can do it because they're backed up by deposit insurance and central bank lending. A crypto exchange doing it would likely go bust sooner or later; this may have already happened and been called a "hack," but people are learning not to trust sketchy exchanges. In some future crypto-based world, exchanges can be fully audited on a blockchain. Using technologies like Plasma you can even have a cryptographic guarantee that you'll be able to get your money back out, even though the exchange itself runs on a fast central database. The sort of crypto bank you're describing would have a hard time competing with that.
  - landryraccoon 8y ago
    The crypto bank that puts deposits to work can pay interest. The 100% reserve bank can’t. That’s how it competes. Consumers will use it because they already use banks without 100% reserves such as Bank of America, HSBC, any current bank in the banking system...
    - DennisP 8y ago
      Yes but banks are protected by the mechanisms I mentioned.
  - mcguire 8y ago
    What happens if financial institutions cannot "create money", i.e. make loans?
    - DennisP 8y ago
      I don't have all the answers about how a new economic system might work, but some possibilities I can think of include: - New cryptocurrencies (possibly built on smart contract platforms) could replicate some features of the banking system - Some loans could be based on deposits instead of new money creation (i.e. the naive view of how banks work) - Easier creation of equity instruments based on crypto tokens could substitute for debt financing One thing that fascinates me about all this is the ease of experimenting with new ideas. I don't know where we'll end up, but I'm optimistic that this messy process will end up advancing civilization.

by lifty 8y ago

gmueckl 8y ago

No. I could go and found a bitcoin bank in which anyone can open an account. The catch? The bank runs a single wallet to back all accounts. The only promise made by the bank is that if you deposit X bitcoins, you'll get X bitcoins back when you request to withdraw them. I'll also allow you instant transfers between the accounts. They are off the blockchain, managed only in the bank's database, so these transactions can be arbitrarily fast. If the wallet accumulates enough bitcoins so that it exceeds the normal volume of deposits and withdrawals, I'll take the rest and put them to work. Maybe buy shares in companies or so. I'll keep the earnings of these investments. If I make a loss, I'll have to recover the loss somehow. That's the risk I take. At that point, I'd have created virtual bitcoins in the market. And who would be stopping me?

lifty 8y ago
That outcome is certainly possible. But even that scenario would be quite a departure from what we have now, where banks have almost no reserve requirement and they can create as much money as can be absorbed in the economy, which in turn is influenced mainly by central bank interest rate. Lending money entails risk and in a situation where the interest is set by a central bank and there are little to no reserve requirements, that risk gets shifted to the population that has to bailout the banks. In the scenario that you outlined, its probable that the reserve would much higher than the current 1-3%, which would lead to risk being more directly held by the bank making the loans and the depositors of that bank. And the argument goes that this might lead to more skin in the game and probably less reckless behaviour. Also, in such a system interest rates would be set by the market, based on the amounts of savings in the economy and the demand for loans.
- deleted 8y ago
  [deleted]
- lokedhs 8y ago
  I just don't see your reasoning. By what mechanism that is not provided today would the banks stop doing what they do today? What mechanism would control the exposure that banks take on?
  - lifty 8y ago
    Bitcoin and other cryptocurrencies are easier to store securely compared to bunches of cash, which would lead to less pressure to store them in a bank. Deposits would be incentivised using interest rates (set by the market). That and the banks not being able to create money would lead to them being more dependent on deposits; this in turn would put more pressure on banks that exhibit risky behaviour and favour banks that keep a healthy balance sheet. And why would there be more pressure to adjust risky behaviour? Because people would take their money out of banks that exhibit that behaviour, which would re-inforce behaviour that has the right ratio of risk/return. This does not happen now because banks don't need almost any deposits to make profit. This risk adjustment already happens in financial sectors that have skin in the game. For example, if a hedge fund looses money, sooner or later people will take their money out of it.
- jhanschoo 8y ago
  > But even that scenario would be quite a departure from what we have now, where banks have almost no reserve requirement and they can create as much money as can be absorbed in the economy, which in turn is influenced mainly by central bank interest rate. I don't see how a Bitcoin bank as outlined above can be regulated to have a reserve requirement either. Arguably, this offers even less protection than a traditional bank, due to the inability of the public sphere to regulate it. And still, as long as a Bitcoin bank is perceived as sufficiently trustworthy based on past behavior, people would use it. Next, I don't share your view that interest rates being set by the market is a good thing. Economies were far more fragile and volatile back when they were backed by bullion. The vast majority of people who have income from labor comparable to their net worth prefer that their net worth not fluctuate so much that they may not consistently maintain their standard of living, and this is helped by a steady interest rate. A rational agent prefers this unless their net worth greatly eclipses their ability to obtain wealth from other forms of capital.
DennisP 8y ago
In today's world, a regulated exchange is prevented by law and auditors from doing that. Banks can do it because they're backed up by deposit insurance and central bank lending. A crypto exchange doing it would likely go bust sooner or later; this may have already happened and been called a "hack," but people are learning not to trust sketchy exchanges. In some future crypto-based world, exchanges can be fully audited on a blockchain. Using technologies like Plasma you can even have a cryptographic guarantee that you'll be able to get your money back out, even though the exchange itself runs on a fast central database. The sort of crypto bank you're describing would have a hard time competing with that.
- landryraccoon 8y ago
  The crypto bank that puts deposits to work can pay interest. The 100% reserve bank can’t. That’s how it competes. Consumers will use it because they already use banks without 100% reserves such as Bank of America, HSBC, any current bank in the banking system...
  - DennisP 8y ago
    Yes but banks are protected by the mechanisms I mentioned.
- mcguire 8y ago
  What happens if financial institutions cannot "create money", i.e. make loans?
  - DennisP 8y ago
    I don't have all the answers about how a new economic system might work, but some possibilities I can think of include: - New cryptocurrencies (possibly built on smart contract platforms) could replicate some features of the banking system - Some loans could be based on deposits instead of new money creation (i.e. the naive view of how banks work) - Easier creation of equity instruments based on crypto tokens could substitute for debt financing One thing that fascinates me about all this is the ease of experimenting with new ideas. I don't know where we'll end up, but I'm optimistic that this messy process will end up advancing civilization.