End Fractional Reserve to End Bank Runs

Bringing "Not your keys, not your coins" to Fiat

With this second Global Financial Crisis in just 15 years — there are dogs older than that — some people would like to stop this endless loop of Boom, Bust, Panic, Bailout.

The answer is very simple: banks should actually have the cash they claim to have.

Of course, Bitcoin fixes this instantly — your keys, your money. And to fix fiat bank crashes once and for all we need to bring that Bitcoin model into banking.

Fortunately, voters are hungry for solutions: A Reuters poll said 84% of American are opposed to using taxpayer money to bail out irresponsible banks, far higher than in the 2008 crisis when voters were willing to believe Wall Street’s propaganda. At this point, voters are done with it.

Why Do Bank Panics Happen?

What causes bank panics is very simple: banks don’t have the money they claim to have.

There’s a technical word for this: bankruptcy. And banks move heaven and earth to hide it — in some countries it’s literally illegal to spread rumors of a bank run.

Why are banks bankrupt? Because they promise depositors can have their money at any moment yet the banks have lent it out.

What they should do instead is back your checking account (“demand deposits”) with actual cash, and then offer higher rates so you’ll park money in a time deposit (Certificate of Deposit, or CD) and lend that out. Then, like any other company, banks can honestly manage assets and liabilities all nice and matched up.

Fractional Reserve Banking

When banks pretend to have money on hand, it’s called Fractional Reserve Banking. Economically, it’s akin to licensed counterfeiting, with banks effectively recycling a bank deposit again and again. Like a waiter bringing the same glass of wine to table after table, each time waiting til you look away to replace it with a photograph of wine.

Why do banks do this? So they can pay you peanuts while running your money like a leveraged bond fund. Grandma accepts peanuts — currently 0.25% annual bank interest — because she thinks her money is safely locked away.

In fact, grandma’s money is already gone, probably before she got home. Flown off somewhere exotic, dancing in the pocket of some techbro or hedge fund speculating on pork bellies or shitcoins. Earning similar exotic rates of return — perhaps double digits — that trickle down to a 0.25% return on grandma’s life savings.

This might strike you as fraud. After all, the banks are very aware that risk-adjusted returns on speculative start-up loans are not 0.25%, therefore grandma is emphatically not aware what’s happening. And centuries of common law ays a contract where one party does not understand is invalid, and if the other party knowingly persists it is fraud.

Banks, of course, say it’s all grandma’s fault — she should have read the fine print. Alas, fraud does not hinge on what bankers think grandma should do, rather what grandma actually does. And grandma, indeed substantially all depositors, emphatically do not understand their bank accounts are parked in exotic gambles. When they find out — when the bank doesn’t have the cash — they panic.

So, yes, fractional reserve is not only destroying the world, according to centuries of jurisprudence it is fraud.

How to Fix Banks?

The solution is also very simple: require cash backing of demand deposits.

This means your checking account is actually backed by cash in the vault. While your longer-term savings might be in a time deposit that banks are free to lend out. Given about 20% of bank deposits today are checking and the rest savings, we might imagine that 20% would be cash-backed, and the rest lent out.

Banks hate this, of course: not only are 20% of deposits not earning their speculative interest, but they’d have to offer you higher rates to get you into those CD’s.

As an economy, you keep the startup capital and mortgages — after all, 80% of money is still being lent out. While the “frozen” 20% simply transfers its buying power to the other 80, so economically it sums to 100% of money still deployed.

Meanwhile, you completely cut out the cancer of fractional reserve, smashing up those little counterfeiting machines hidden in every single bank branch across America — indeed, across the world. They can no longer pyramid tokens on top of tokens, turning the financial system into a fragile house of cards.

Even bigger, this means a radical reduction in inflation, in fact probably completely eliminates inflation. The Fed would still print, sure, but the Fed’s only 25% of money printing — the rest is fractional reserve — so the 25% would be gobbled up by economic growth. Not hard money, but a damn sight closer to hard money.

Does Bitcoin Fix This?

Of course Bitcoin fixes this! But with a big caveat: Bitcoin only protects if you self-custody your bitcoin or if you can transparently verify ownership of your coins. If not, an intermediary could pretend to be holding your Bitcoin for you but could have done what the banks do and relend it or sell it and lend the proceeds.

There is actually speculation that large quantities of such “paper Bitcoin” do exist in some of the shadier exchanges. In which case you’d probably want to get your coins off those exchanges fast.

And, for the record, if we discover that a lot of Bitcoin is fractionally reserved “paper Bitcoin,” it’s actually very good for Bitcoin’s price.

Because the fraudulent coins will evaporate, of course, but Bitcoin price goes up because the defrauded HODLers would now have unsatisfied demand for Bitcoin. They’re poorer than before, yes, but they’re also hungry for new Bitcoin. As Ben Franklin put it, “experience is a dear school, yet some will learn at no other.”

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