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Peter Šurda
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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.
By
Jon Matonis
American Banker
Friday, March 15, 2013
http://www.americanbanker.com/bankthink/how-cryptocurrencies-could-upend-banks-monetary-role-1057597-1.html
