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The author says "MtGox operated at fractional reserve for years". A better and more conventional way to put it: it was insolvent for years.

dec0dedab0de 12y ago
aren't they essentially the same thing?
- haberman 12y ago
  When you operate a fractional reserve, other people/businesses owe you at least as much money as you owe to your deposit accountholders. When you're insolvent, you can't cover your obligations. Even if you called in every loan you'd made, it still wouldn't give you enough cash that all your deposit account customers could withdraw all their money. Calling Mt. Gox a "fractional reserve" is giving them way too much credit.
  - wongarsu 12y ago
    Being insolvent means that they can't cover your obligations right now. If you deposit 100BTC in my wallet, I invest it for a year and you want it back right now I'm insolvent because I can't pay you right now; despite my books being perfectly balanced. In the event of everyone wanting to withdraw their money at once, operating a fractional reserve and being insolvent are basically the same (unless you can instantly get the money out of your investments). That's a major reason why fractional reserve banking is frowned upon in the bitcoin ecosystem.
    - roblev 12y ago
      Fractional reserve banking can be done with bitcoin just as with any underlying "base asset" such as gold or Federal Reserve Banknotes. It just means that the banks can lend most of the asset, and must keep back a fraction for liquidity purposes (in case a depositor wants some of their asset back). In many ways Fractional Reserve Banking would be much more risky with bitcoin than with banknotes; with banknotes at least there is a lender-of-last-resort central bank. The central bank can create additional money at will to lend to a bank that is in a liquidity crisis, to see it through the crisis. With bitcoin, there is no such operator. Now if nobody ever lends or borrows bitcoin, then there will be no issue - but lending and borrowing has been quite central to commerce over the last couple of centuries, with mostly decent effects. Personally I'm not sure bitcoin economics are that well thought out!
      - Frozenlock 12y ago
        You are conflating lending and fractional reserve. It's possible to have lenders and borrowers without operating a fractional reserve.
        roblev 12y ago
        Well as I see it there are only really two possibilities: full reserve or fractional reserve, and I've never really seen full reserve banking (i.e. demand deposits cannot be lent). But please explain if you mean something else.
        Frozenlock 12y ago
        I don't. With a full reserve, demand deposits shouldn't be lent, but term deposits can be. With this, you maintain a full reserve and continue to have lenders/borrowers.
        dragonwriter 12y ago
        Lending term deposits cannot provide a guarantee of full reserve, because term deposits mature and you cannot absolutely guarantee that you will have reserves on hand to meet them when they mature. You can have "full reserve" of demand (including matured term) deposits as a goal and lend out term deposits, but you get at best a statistical probability approaching -- but never equaling -- unity of maintaining full reserve based on past repayment and new deposit patterns.
        Frozenlock 12y ago
        And? Demand deposits are still 100% whole.
      - wongarsu 12y ago
        Sure fractional reserve banking can be done with bitcoin. It's not a problem of the currency but of the environment and ecosystem. A regular bank is well-trusted and insured. A bank run is unlikely because of the trust and even in that case the insurance or a lender can keep the bank solvent. A bitcoin bank is at best moderately trusted and is almost always uninsured. Minor events can lead to panic which leads to a bank run, which leads to insolvency because there is neither insurance nor a good lending infrastructure available to most bitcoin banks. Concerning lending: there is a small but growing bitcoin lending community, but it's closer to Kickstarter or the VC model. Credits are not given out by banks but by a number of small investors. It's not very efficient yet, but it kind of works.
    - NeutronBoy 12y ago
      > Being insolvent means that they can't cover your obligations right now No, it doesn't. If it did it would mean that everyone with a mortgage is insolvent, as would most businesses (what sort of business keeps a 1:1 debt/cash ratio?). What insolvent means is that you don't have enough cash, and/or assets with enough liquidity to be able to pay your debts. Banks are fine, because for the most part they can sell debtors for cents on the dollar when they really need the cash.
  - dec0dedab0de 12y ago
    That was mostly meant to be a bit snarky, however your explanation is fair enough for the pedantic in me.
- imaginenore 12y ago
  No. Fractional reserve assumes people owe you and your books balance perfectly fine. Insolvency means you fucked up.
- Lazare 12y ago
  Insolvent: Liabilities exceed assets. Illiquid: Immediate demands for cash exceed liquid assets. Fractional reserve banking: Short term deposits are lent out as long term loans. Under normal conditions, a bank has capital (ie, its assets exceed its liabilities). The capital acts as a cushion, which means it is not insolvent, and not likely to become insolvent. On the other hand, fractional reserve banks are prone to liquidity crises (aka, a bank run), because while the bank will pretty much always have enough assets to give all depositors their money back, it will pretty much never have enough to do so immediately. Which is why real banks have depositor insurance (and also why depositor insurance is affordable to provide). The article is describing MtGox as being insolvent; and despite incorrectly using the term, it's not describing fractional reserve banking, and the two are not the same thing. MtGox didn't make long term loans (or any loans), and it did not suffer a liquidity crisis. It was insolvent because the money was stolen. It's a vastly different thing.
- christbitcoin 12y ago
  No. If I accept $10 in deposits, make $8 in loans, and have $3 of cash on hand, I'm operating a fractional reserve. I have $11 in assets ($3 cash, and $8 of loans receivable), and $10 in liabilities (cash owed to depositors). There's some risk if my loans go bad, but it's fundamentally sane. Insolvency, on the other hand would be if I accept $10 in deposits, make $8 in loans, and have $0 cash on hand. At this point, I'm insolvent. There's no reason to believe I can pay back my depositors because my liabilities are greater than my assets. Even if all the loans are repaid, I simply don't have the money.

dec0dedab0de 12y ago

aren't they essentially the same thing?

haberman 12y ago
When you operate a fractional reserve, other people/businesses owe you at least as much money as you owe to your deposit accountholders. When you're insolvent, you can't cover your obligations. Even if you called in every loan you'd made, it still wouldn't give you enough cash that all your deposit account customers could withdraw all their money. Calling Mt. Gox a "fractional reserve" is giving them way too much credit.
- wongarsu 12y ago
  Being insolvent means that they can't cover your obligations right now. If you deposit 100BTC in my wallet, I invest it for a year and you want it back right now I'm insolvent because I can't pay you right now; despite my books being perfectly balanced. In the event of everyone wanting to withdraw their money at once, operating a fractional reserve and being insolvent are basically the same (unless you can instantly get the money out of your investments). That's a major reason why fractional reserve banking is frowned upon in the bitcoin ecosystem.
  - roblev 12y ago
    Fractional reserve banking can be done with bitcoin just as with any underlying "base asset" such as gold or Federal Reserve Banknotes. It just means that the banks can lend most of the asset, and must keep back a fraction for liquidity purposes (in case a depositor wants some of their asset back). In many ways Fractional Reserve Banking would be much more risky with bitcoin than with banknotes; with banknotes at least there is a lender-of-last-resort central bank. The central bank can create additional money at will to lend to a bank that is in a liquidity crisis, to see it through the crisis. With bitcoin, there is no such operator. Now if nobody ever lends or borrows bitcoin, then there will be no issue - but lending and borrowing has been quite central to commerce over the last couple of centuries, with mostly decent effects. Personally I'm not sure bitcoin economics are that well thought out!
    - Frozenlock 12y ago
      You are conflating lending and fractional reserve. It's possible to have lenders and borrowers without operating a fractional reserve.
      - roblev 12y ago
        Well as I see it there are only really two possibilities: full reserve or fractional reserve, and I've never really seen full reserve banking (i.e. demand deposits cannot be lent). But please explain if you mean something else.
        Frozenlock 12y ago
        I don't. With a full reserve, demand deposits shouldn't be lent, but term deposits can be. With this, you maintain a full reserve and continue to have lenders/borrowers.
        dragonwriter 12y ago
        Lending term deposits cannot provide a guarantee of full reserve, because term deposits mature and you cannot absolutely guarantee that you will have reserves on hand to meet them when they mature. You can have "full reserve" of demand (including matured term) deposits as a goal and lend out term deposits, but you get at best a statistical probability approaching -- but never equaling -- unity of maintaining full reserve based on past repayment and new deposit patterns.
        Frozenlock 12y ago
        And? Demand deposits are still 100% whole.
    - wongarsu 12y ago
      Sure fractional reserve banking can be done with bitcoin. It's not a problem of the currency but of the environment and ecosystem. A regular bank is well-trusted and insured. A bank run is unlikely because of the trust and even in that case the insurance or a lender can keep the bank solvent. A bitcoin bank is at best moderately trusted and is almost always uninsured. Minor events can lead to panic which leads to a bank run, which leads to insolvency because there is neither insurance nor a good lending infrastructure available to most bitcoin banks. Concerning lending: there is a small but growing bitcoin lending community, but it's closer to Kickstarter or the VC model. Credits are not given out by banks but by a number of small investors. It's not very efficient yet, but it kind of works.
  - NeutronBoy 12y ago
    > Being insolvent means that they can't cover your obligations right now No, it doesn't. If it did it would mean that everyone with a mortgage is insolvent, as would most businesses (what sort of business keeps a 1:1 debt/cash ratio?). What insolvent means is that you don't have enough cash, and/or assets with enough liquidity to be able to pay your debts. Banks are fine, because for the most part they can sell debtors for cents on the dollar when they really need the cash.
- dec0dedab0de 12y ago
  That was mostly meant to be a bit snarky, however your explanation is fair enough for the pedantic in me.
imaginenore 12y ago
No. Fractional reserve assumes people owe you and your books balance perfectly fine. Insolvency means you fucked up.
Lazare 12y ago
Insolvent: Liabilities exceed assets. Illiquid: Immediate demands for cash exceed liquid assets. Fractional reserve banking: Short term deposits are lent out as long term loans. Under normal conditions, a bank has capital (ie, its assets exceed its liabilities). The capital acts as a cushion, which means it is not insolvent, and not likely to become insolvent. On the other hand, fractional reserve banks are prone to liquidity crises (aka, a bank run), because while the bank will pretty much always have enough assets to give all depositors their money back, it will pretty much never have enough to do so immediately. Which is why real banks have depositor insurance (and also why depositor insurance is affordable to provide). The article is describing MtGox as being insolvent; and despite incorrectly using the term, it's not describing fractional reserve banking, and the two are not the same thing. MtGox didn't make long term loans (or any loans), and it did not suffer a liquidity crisis. It was insolvent because the money was stolen. It's a vastly different thing.
christbitcoin 12y ago
No. If I accept $10 in deposits, make $8 in loans, and have $3 of cash on hand, I'm operating a fractional reserve. I have $11 in assets ($3 cash, and $8 of loans receivable), and $10 in liabilities (cash owed to depositors). There's some risk if my loans go bad, but it's fundamentally sane. Insolvency, on the other hand would be if I accept $10 in deposits, make $8 in loans, and have $0 cash on hand. At this point, I'm insolvent. There's no reason to believe I can pay back my depositors because my liabilities are greater than my assets. Even if all the loans are repaid, I simply don't have the money.