As we continue to debate the proper roles of crypto and lending, bitcoin full reserve can be the future for credit and commerce.
This is an opinion editorial by Stephan Livera, host of the “Stephan Livera Podcast” and managing director of Swan Bitcoin International.
The debate rages on about what the proper roles of bitcoin, “crypto” and lending should be. What kind of credit should we have, if any? What is fiduciary media and do we need it? Or should it all be fully reserved?
In this article I will spell out some thoughts on this long-running debate and how it applies in a Bitcoin context.
For the impatient, the short answer is: We don’t need fractional-reserved fiduciary media for credit and commerce to exist in society. You can have commodity credit in a full-reserve banking system, it merely stops circulation credit and the creation of fiduciary media. The defense of “free” fractional-reserve banking amounts to a kind of special pleading, inflationist stance. This does not preclude the fact that there will be many who try to commit fractional-reserve banking fraud, but “the market” does not necessarily have to serve this demand, nor is it beneficial to society.
Now, some in the full reserve camp will downplay or skip over the first point around fraud, as they believe that even if we disregard the fraud argument, there are still negative economic consequences in a society that tolerates fractional-reserve banking.
Austrian economists in the full-reserve camp include Ludwig von Mises, Murray Rothbard, Jesús Huerta de Soto, Hans-Hermann Hoppe, Joseph T. Salerno, Jörg Guido Hülsmann, Philipp Bagus, David Howden and Robert P. Murphy. This camp would generally believe that reserve ratios of banks should and/or would remain at or near 100%.
Those who take the “free banking” view generally argue that “free market, fractional-reserve” banking regimes can be laissez-faire, and work in a stable way. They believe that bank reserve ratios could sustainably operate in the 2% to 5% range. There may be some bank failures but “free bankers” may put this down to bad government regulation. Well-known economists and proponents here include Larry White and George Selgin.
Imagine for a moment that a bank had 100 gold ounces in its vault. And it issues out paper tickets, each representing one gold ounce, for the community to trade around in place of carrying around the gold (and verifying it and measuring it, etc). So long as the bank only issues out up to 100 paper tickets, there is no fiduciary media. One customer could come and deposit five tickets with the understanding that they are relinquishing control for a given time period. The bank could loan those five tickets out to another customer, and this would be consistent with commodity credit.
Now, imagine that bank issued out 150 paper tickets (each purporting to represent an ounce of gold), but it only had 100 gold ounces in the vault. In this situation, we have a creation of fiduciary media. Those additional 50 tickets (above and beyond the genuine 100) represent claims to gold ounces that literally do not exist.
Banks creating loans and credit by issuing fiduciary media are granting circulation credit. This is what the Misesian and Rothbardian Bitcoiners are objecting to. We generally argue that a system of fractional reserve banking is only sustainable with government intervention, typically a central bank lender of last resort, or with government granted permission for banks to not grant in-specie redemption (i.e., not letting customers withdraw their coins).
“Today, bitcoiners are gleeful about the collapse of credit in the crypto industry.”
So, as mentioned above, yes I do believe fractional-reserve banking is fraud, but no, I disagree with what Carter is implying here. Fractional-reserve banking has had the backing of the State, and therefore this outcome we’re living in today was a result of political entrepreneurship, rather than genuine free market entrepreneurship.
“The banker turned fraud who issues the first uncovered money title is in fact a ‘political entrepreneur.’ He ‘tests the market’ to discover how far he can go in violating property rights without encountering resistance.”
See also this interesting section by Hülsmann:
“A large number of fractional-reserve banks, to say the least, have used such words intentionally in two mutually exclusive senses and that this usage has concealed underlying real differences. These banks’ customers were led to believe that they had bought a financial product of type A, but in legal settlements they were told that they actually had bought a product of type B.”
“Celsius has set the stage for conflict between its customers and its sophisticated institutional creditors — in particular, Celsius has pointed out in its pleadings that customers transferred ownership of crypto assets to Celsius, making those customers unsecured creditors. This detail may undercut customer expectations, who thought they were depositing their assets into a construct similar to a traditional bank.”
“During Scottish ‘free banking,’ a fully laissez-faire, markets-based system, reserve ratios were commonly 2-5%, and the system worked swimmingly.”
Not so fast! There were entire stretches of time where some of these so-called “free market” free bankers were permitted to not redeem in specie (i.e., they could freeze customer withdrawals), while at the same time, still enforce payment obligations on other people. Isn’t this curious? How can the “free bankers” herald Scottish free banking when customer redemptions were not permitted for a period of over 20 years?
“From the beginning, there is one embarrassing and evident fact that Professor White has to cope with: that ‘free’ Scottish banks suspended specie payment when England did, in 1797, and, like England, maintained that suspension until 1821. Free banks are not supposed to be able to, or want to, suspend specie payment, thereby violating the property rights of their depositors and noteholders, while they themselves are permitted to continue in business and force payment upon their debtors.”
Later, Carter is talking about credit in general:
“A world with no credit is a dismal one. Credit — responsibly extended — is the cornerstone of civilization. It unleashes savings and puts the money to work in productive areas of the economy. A world without credit is a sterile, stagnant one.”
So, as discussed above, the key distinction to understand here is commodity credit (OK) versus circulation credit (fraudulent and causes economic instability). Once we make this distinction, it is all much clearer.
To spell this out: From a Rothbardian Bitcoiner point of view, in principle there could be a bitcoin bank that takes in bitcoin, and loans out commodity credit loans denominated in bitcoin — and there’d be no issue as there is no fiduciary media created. It’s just that today, such a proposition would be extremely high risk as very few entrepreneurs and businesses have successfully ROI’ed in bitcoin terms over longer periods of time. In this sense, there would be very few customers and very few lenders willing to take this kind of risk for appreciable bitcoin sums over an appreciable time period. In practice, this kind of thing might more realistically occur post-hyperbitcoinization or closer to it.
“But were they? If their victory condition is ‘no credit is ever extended based on a crypto asset ever again,’ they guarantee a loss.”
So, as above, the distinction to keep in mind is commodity credit versus circulation credit. I believe that commodity credit could theoretically work under a Bitcoin standard with full-reserve banking. Therefore, my point is not “no credit ever” and Carter’s statement here is overly reductive.
Also while we’re here, it’s worthwhile pointing out that this specific debate about “free banking” fractional reserve versus full reserve isn’t really a question of Maximalism per se. It’s an orthogonal debate as a person could conceivably be a “free banker” and Maximalist, or they could be in favor of full reserve and Maximalist.
“The desire for leverage and a lower cost of capital on one hand, and yield on the other, is inherent to free, capitalist enterprise, and that urge will never disappear.”
Of course people want leverage. The question is, can it be ethically and sustainably provided? And would it be beneficial to society? Under a fractional-reserve banking system with fiduciary media, sure, it can be provided — the challenge and question is more about whether such a thing is ethical or desirable for the overall economy. I say no, it’s not. It does not enrich society on the whole, it merely enriches those getting the newly-printed tokens first, and bankers servicing those interests.
Speaking of Bitcoin Maximalists warning about fractional-reserve practices, Carter mentions:
“They cannot extinguish the demand for credit or yield — and entrepreneurs will always emerge to fill this need.”
And I’d respond that such a system would be unethical and it would be inherently unstable without a lender of last resort. And if that lender of last resort cannot print tokens (which obviously can’t be done in Bitcoin beyond 21 million coins), then the system won’t be long-term sustainable.
It could even seem sustainable for a period of time, but such a system cannot possibly be useful for the economy as a whole. If fractional reserve banks are permitted to increase the quantity of money titles (e.g., bitcoin IOUs), this merely enriches some market participants at the expense of all others.
From my perspective, people will need to learn the difference between bitcoin for which they hold the private keys, and mere bitcoin IOUs. If people blur the line here, or perhaps even equivocate the different IOUs of different providers (say a Celsius bitcoin IOU with a Voyager bitcoin IOU), this more easily opens the door to widespread fractionally-reserved coins that effectively go above the 21 million cap.
Of course, this risk may not be systemic, it would be localized to those individuals who are overly trusting of other peoples’ IOUs. Nevertheless, it’s worthwhile for bitcoin HODLers and users to understand this crucial difference.
The disagreement in this case would be on what the reserve ratio should be, as “free bankers” may conceivably be fine with a reserve ratio of 2%, while full-reserve Bitcoiners want a 100% reserve ratio.
The fiat USD being loaned out for these loans is obviously still a part of the broader USD fractional-reserve banking system.
Without fractional-reserve lending subsidized by cheap debt, investors may reach a saturation point sooner with their capital. If time preference and interest rates are genuinely very low, investors may not want to take the risk of loaning out bitcoin via a debt instrument, given that the interest rate offered is very low. Investors may very much prefer to give some bitcoin in exchange for an equity share in a business.
So, on this basis, there may legitimately be an argument that there would be very little commodity credit extended anyway. In this world, we’d see far less debt issued, and more equity investment.
If you believe in the Bitcoin saying “not your keys, not your coins,” then you too are in favor of full-reserve bitcoin. The view implied by those who want to permit “free” fractional-reserve banking is one where there are multiple claimants to the same coins or same resources of society. This difference cannot be squared in my view.
It’s also important to understand that there are legitimate arguments as to how and why we ended up in a fractional-reserve system that was not the result of a free market. Of course, bankers are always trying to do this, because it allows them to profit massively! The “free-banking” movement is special pleading on behalf of inflationary commercial banks.
Society would not be less vibrant in a world without fractional reserve banking. If anything, the society we live in today is more sterile and stagnant because of the artificial boom and bust conditions that capitalist investors and entrepreneurs have to deal with. Moving to a bitcoin full reserve system could in practice make society far more prosperous with continued sustainable growth, rather than “lumpy” artificial booms followed by busts.
This is a guest post by Stephan Livera. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.