By Jon Matonis
American Banker
Friday, March 15, 2013
http://www.americanbanker.com/bankthink/how-cryptocurrencies-could-upend-banks-monetary-role-1057597-1.html
|
Peter Šurda |
I recently had a fascinating chat with the economist Peter Šurda to
discuss how nonpolitical cryptocurrencies like bitcoin could alter the
future of
fractional reserve banking.
Peter is also a software developer experienced in the online payments industry and will present at the
Bitcoin 2013: The Future of Payments conference in San Jose in May. His 2012 master's thesis at Vienna University of Economics and Business was entitled
Economics of Bitcoin: Is Bitcoin an Alternative to Fiat Currencies and Gold?
He's an abstract thinker, but the implications of his work are
tantalizing: that digital money like Bitcoin opens up possibilities for
banking without central planners or a lender of last resort, where
interest rates and reserve requirements are driven purely by the market.
The debate between the full reserve bankers and the fractional reserve bankers is an old one and it has been
explored in depth by the
Austrian school of economics.
More recently, the debate has been broadened to include the dynamics of
introducing the bitcoin cryptocurrency, which is the functional
equivalent of digital gold, since its supply is predictable and fixed.
(There are currently 10.9 million bitcoins in circulation with a
total fixed supply of 21 million expected to be mined before 2140, 99% of them by the year 2032.) The Austrian school economist
Michael Suede and the technologist
Eli Gothill
have speculated that fractional reserve banking can indeed appear
within a bitcoin monetary environment. This is where we join up with
Peter.
JON MATONIS: I enjoyed your blog post,
"Market Forces and Fractional Reserve Banking." Do you consider fractional reserve banking to be compatible with Austrian economics?
PETER
ŠURDA: First of all, I would like to separate fractional reserve
banking and credit expansion. On one hand, there are ways of increasing
the money supply, in the broader sense, which do not require fractional
reserve banking or changes in the monetary base such as a system based
on the principle of mutual credit like LETS [
local exchange trading systems], or a fiat currency that uses bitcoin as reserves (i.e. they are not claims in the sense that
Ludwig von Mises
uses them, but they act as full substitutes). From the opposite
direction, fractional reserve banking does not necessarily lead to
credit expansion.
I agree with the full reservists that credit expansion has the effects described by the
Austrian Business Cycle Theory. However, I agree with the
free bankers
that fractional reserve banking is not necessarily a violation of
property rights and other ways of increasing the money supply also are
not necessarily a violation of property rights.
So I think that
the economic and legal analysis are two separate issues and need to be
addressed separately. I avoided the legal analysis in my thesis and
concentrated on Austrian Business Cycle Theory and policy issues, but in
an earlier draft I have several pages about legal aspects too, and I
discussed the topic with [the legal theorist]
Stephan Kinsella.
JON
MATONIS: How does a nonpolitical cryptocurrency like bitcoin alter the
landscape in the "full reserve" versus "fractional reserve" banking
debate?
PETER ŠURDA: Austrians have made arguments in the past
that lead to the conclusion that fractional reserve banking does not
necessarily lead to credit expansion, even though they never explicitly
formulated it this way and might not have realized the connection. The
reason is that if credit instruments do not decrease transaction costs
over the monetary base, they are unlikely to act as a part of the money
supply. Bitcoin shows that this is not only a hypothetical but
empirically possible to implement. With Bitcoin, it is much less likely
that credit expansion will occur.
In other words, we need to
separate two things. Why do people want to hold fractional reserve
banking instruments, which may include the interest payments as one of
the reasons, and why do people want to use fractional reserve banking
instruments as a medium of exchange which, I argue, requires that the
fractional reserve banking instruments decrease transaction costs. That
they historically manifested themselves through a common instrument is
an empirical quirk and not an economic rule. The ability to loan money
is beneficial. Contrary to many Austrians, I agree that
maturity transformation
can be beneficial, and if the loan ends up being a liquid instrument,
it also can be beneficial. But if it is so liquid that it becomes a part
of the money supply, that's when it has a detrimental effect on the
economy.
For full reservists, Bitcoin shows that the question of
fractional reserve banking is less important than they thought.
Fractional reservists, on the other hand, need to think about the nature
of the mechanisms equilibrating the money supply. I tried to explain
the issue to [the economists]
George Selgin and
David Glasner in comments on their websites, but I wasn't successful in getting my point through.
JON
MATONIS: If bitcoin is digital gold, does that portend a future where a
bitcoin standard (akin to the gold standard) can emerge or partial
bitcoin backing for other currencies?
PETER ŠURDA: They probably
can emerge, but the more important question is whether they would be
preferred to bitcoin. Only something that provides a significant
improvement would be preferred. I only know two potential candidates for
that:
Ripple and
OpenTransactions.
JON MATONIS: In a bitcoin world, is fractional reserve banking only possible with offline substitutes (such as
physical coins or
cards, which can be traded hand-to-hand, containing the private key to a bitcoin address) or an intentional "fork" in the
block chain ledger?
PETER
ŠURDA: Hypothetically, the reserves can be offline and the substitute
can be a clearing system like Ripple, so there are other possibilities
too. But if I understand your point correctly, offline "substitutes"
might have a higher chance of actually becoming full substitutes because
they might have more obvious advantages.
JON MATONIS: As the recent block chain fork
episode demonstrates, there is a need for
offline bitcoin transactions to continue. Is this demand sufficient for a
money substitute to evolve, such as offline substitutes with full or partial bitcoin backing?
PETER
ŠURDA: This is primarily an empirical question, so we can't be
completely sure about that. I think the probability for this is
significantly lower than with the currencies that we've known
historically. The end result is also path-dependent; for instance, it
depends on how quickly bitcoin matures and/or adapts to changes compared
to the potential substitute.
Fractional reserve banking does not
come into existence magically. It must follow economic rules. With gold
and similar commodities, fractional reserve banking comes into existence
for these reasons: On the demand side, there is a demand for money
substitutes, because they provide something that money proper does not;
and on the supply side, money substitutes carry maintenance costs for
the issuer (e.g. storage of gold) and these need to be offset somehow.
The issuer can charge on holding (e.g.
demurrage
of bank notes), transacting (e.g. check clearing), or, obviously,
externalize the costs through fractional reserves. From the point of
view of an individual user, fractional reserve banking appears to be the
least costly alternative. So obviously fractional reserve banking wins.
Putting
it together: If there is a general demand for money substitutes, this
leads to fractional reserve banking. Unless it's illegal. Then it might
not. Solution: Have money which does not lead to the creation of money
substitutes. Bitcoin shows that at least hypothetically, this is
possible. I might even go a bit further and make this statement: If on a
free market money substitutes do not develop even though there is no
legal or technical obstacle for them, it means that the choice of money
is
Pareto-optimal since no change in the monetary system leads to an increase in utility.
JON MATONIS: Does a demand for positive return on bitcoin balances lead
to an environment of competitive bank lending with risk-adjusted
interest rates? And will this lead to an environment of fractional
reserve banking with depositors offered higher interest rates in
exchange for the additional risk premium of running a fractional
portfolio?
PETER ŠURDA: Yes, I would say it does, but until there
are industry niches that primarily use bitcoin, it is probably not much
different from gambling.
This might lead to
negotiable credit instruments with
maturity-mismatching
or maturity transformation, depending on which economic school you use
for terminology. However, I don't think this feature alone is sufficient
for these instruments to be accepted as full substitutes whereas George
Selgin appears to think it is. Now, whether to call such a situation
"fractional reserve banking" even though no credit expansion occurs is
unclear. I lean towards yes, but there could be other interpretations.
JON MATONIS: How do you see bitcoin changing interest rate structures and lending practices?
PETER
ŠURDA: Using Bitcoin for loans only makes sense for those businesses
that use bitcoin as a unit of account, unless, of course, you're just
speculating on the market but don't actually sell any goods or services.
I think this will only occur at much higher levels of liquidity or
until we can be quite sure that it deserves the label "money." Until
these higher levels of liquidity are reached, the price of bitcoin will
probably be quite volatile, which reduces the likelihood that people use
it as a unit of account.
However, there could be niche market segments that use bitcoin as a primary medium of exchange and [bitcoin]
mining
is the most obvious candidate. For these, the unit of account function
would make sense even if the global market penetration is lower.
Assuming
one of these thresholds is crossed and the money supply remains
inelastic (i.e. no significant credit expansion), the interest rate of
bitcoin should be a good reflection of the time preference of those
market participants that use it as a unit of account. Bitcoin also makes
it much easier for lending to occur in a decentralized manner, I think.
Rather than a small number of "too big to fail" institutions, we should
see smaller specialized teams that act as facilitators without owning
the liabilities or being liable themselves.
JON MATONIS: Can a
free market fractional reserve system (as opposed to a
central banking fractional reserve system) coexist with full reserve banking? Or will one drive out the other?
PETER
ŠURDA: I think that if money substitutes emerge, fractional reserve
banking will out-compete 100% reserve banking in the market. I deal with
this a bit in an earlier draft of the thesis. If they don't emerge, on
the other hand, we'll have a money supply equivalent to the monetary
base and debt will not cause changes in the money supply. It would be
viewed as merely highly liquid credit. I don't think they can coexist
for a long time assuming the same underlying money in the narrower
sense, of course.