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.
The Short Version
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.
Rothbardian full-reserve view are generally arguing that:
Austrian business cycle theory
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.
“Human Action,” commodity credit is the kind permissible under a full-reserve system. It means banks are lending out their own funds or the funds entrusted to the banks by customers.
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.
Bank Charter Act (aka, Peel Act) in the U.K. in 1844, which did mandate 100% reserves for bank note issuance, however, as they did not also mandate 100% reserves on bank demand deposits, the system of fractional-reserve banking still survived. The Peel Act was later suspended.
George Selgin and Murphy debated this topic in 2018. Stephan Kinsella has a reading list post here for those interested. Also of interest will be this Kristoffer Hansen post at Mises.org, “Understanding The Rothbardian Critique Of Free Banking.” I can’t hope to cover every possible aspect of this debate in one post but I will attempt to summarize and respond to key points.
So, What’s The Claim With This Recent ‘Crypto’ Credit Crunch?
Recently, Nic Carter has asserted that this recent “crypto” credit crunch is not the end of crypto lending. He is defending credit and the “free banker” position with some historical parallels to what happened recently with lenders, such as Celsius.
Mt. Gox or QuadrigaCX, it became a lot easier to sell the message of self custody.
Rothbardian ideal, believing fractional reserve banking to be ‘fraud,’ even though the idealized ‘full reserve banking’ generally never emerges in free market conditions.”
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.
When the government puts in central bankers, lenders of last resort, and provides special privileges to bankers e.g., allowing them to deny in-specie redemption to customers and deposit insurance, this gives an artificial privilege that would not exist under a genuinely free market. Hülsmann has written a paper on this idea titled “Has Fractional-Reserve Banking Really Passed The Market Test?” For example, see this section by Hülsmann:
this analysis from a business restructuring lawyer, for instance:
“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.”
And see this video clip compilation of Celsius Network videos where CEO Alex Mashinsky is asserting that “Celsius is a safe place to store your coins” and that “a run on a bank cannot happen at Celsius because Celsius never lends more than what it has.”
this court case). Business and bank failures are a fact of life, whether we live in a full-reserve or fractional-reserve banking world.
Carter claims:
“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?
For evidence, see Rothbard’s writing in “The Myth Of Free Banking in Scotland,” his response to White:
“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.”
Bitcoin Maximalism, speaking of how most Maximalists are simply not interested in non-monetary uses, and commenting on the recent failures of lenders in the space. I commented that there’s a case to say that the Maximalists who encouraged self custody and not putting bitcoin on high-risk platforms were right.
“Speculative Attack,” we may well see individuals leverage up using the fiat system. In this way, they are using the fiat system against itself to stack more sats and perhaps help advance the process of hyperbitcoinization. Now of course this carries risks and costs, but for certain individuals or entities who can access cheap credit, such as MicroStrategy, it might well be reasonable.
vocal proponent of proof-of-reserves technology. This has been implemented in various places in the Bitcoin and “crypto” world, such as at Kraken, Ledn and at previous Bitcoin exchange Coinfloor U.K. (since purchased by Coincorner).
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.
Unchained Capital. Because Unchained loans use Bitcoin multisignature technology, the coins may not be rehypothecated as all three key holders (borrower, unchained and third-party key agent) can confirm exactly what’s happening to the bitcoin on-chain.
The fiat USD being loaned out for these loans is obviously still a part of the broader USD fractional-reserve banking system.
In Practice, Where Are We Going With Debt And Equity Anyway?
Now you could believe that in practice, over the longer term, there won’t be much or any commodity credit extended. Saifedean Ammous argues a similar point in his book “The Fiat Standard: and discussed this with me on “SLP296.”
Pierre Rochard for his feedback on this article.
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.