Can banks "create" Bitcoin

Question

I have a stupid question. Could a commercial bank creates Bitcoins the way it "creates" money if it was allowed to make loans in Bitcoins?

Answer 1

They cannot create more tokens because number of Bitcoins is limited by the code (only 21 million of bitcoins can be ever mined). However, they can increase money supply of bitcoins via lending.

For example, if someone deposits 100 Bitcoins in a private bank and a bank is not forced by regulation or market self-regulation to keep 100% reserve, then they could lend some of that deposit. Let us say they would lend 50BTC and kept 50BTC as a reserve.

Now there is 150BTC in circulation. The original depositor still has 100BTC on his/hers deposit account but now there is also 50BTC loan. This makes total money supply of BTC 150 even if there are only 100 tokens.

Answer 2

Let me begin by saying 1Muflon1's answer should be accepted. It is correct. The only reason that I am answering is that there appears to be some confusion by others about how this would work. In addition, there is a fascinating implication to your question that seems to have been missed.

Let us also dispose of Bitcoin as a currency and replace it with NewCoin. My technical interest in this question stemmed from its statistical properties. I will explain why we need to dispose of Bitcoin. It has undesirable properties.

The use of privately issued token money is not new. George Selgin's excellent book "Good Money" describes the token money created while Isaac Newton was Master of the Mint. If we ignore Newton's scientific work and instead focus on his religious beliefs and ideas around the Mint, he is downright weird.

His unusual ideas created a shortage of coinage, especially in denominations small enough to pay workers or to purchase daily goods. Button makers produced tokens. If you gathered enough tokens, they would redeem them for money from the Mint. I think that may be what is fueling cryptocurrencies. With the US Government's intense tracking of all but the smallest transactions, there is a shortage of non-cash anonymous transaction media. Both the US and the world had an abundance of it once. Of course, one could infer that many of those transactions are illicit from at least some governments' perspectives.

The problem with Bitcoin is that the total number of coins that could be mined is too small to cover the system's needs. It also appears to have a winner's curse problem. Cryptocurrencies are more valuable to some people than to others. The coins will tend to move to people whose preferences would give the coins higher reservation prices. That is not a desirable property for a currency or a medium of exchange.

Currencies do not need banks to exist. The money system on the Island of Yap has always existed without needing to resort to banks. The coins exist in adequate supply for the purposes for which they have always been used. I have not checked for several years, but they do not appear to have been supplanted by a major currency for local use except for imported goods. A single Yap coin can easily weigh a ton.

Because the coins are so large, they are nearly immobile. Their value is based on how difficult moving them into place was. They are also based on a distributed ledger. A coin is transferred by making the community know who the new owner was and what was exchanged. The coins' sizes make them impossible to counterfeit, a physical equivalence to encryption. A two-ton object sitting on the top of a steep hill is not going to be faked and replaced.

Cryptocurrencies have had physical analogs for hundreds of years, even in the United States. What is interesting to me is the implication of your question.

So let us again assume we have a new cryptocurrency called the NewCoin. It comes into existence like other currencies but in smaller denominations. The coin is traded, but it seems to be traded roughly around a steady-state value. Because it is used as a real medium of exchange, banks get interested and offer to make loans and take deposits. Remember that its unique value is that it is decentralized and anonymous.

How do banks get into the NewCoin lending business?

First, they have to set aside capital. Current reserve policies are based on loan riskiness, but we will use the older gold-standard policies. Banks will first buy a base of NewCoins that depends on what they think the demand for NewCoin loans will be. It is the loan demand that is key. The first loans will be to the players that value these loans the most. The last loans will be to those that value them the least.

The banks will make their initial loans, but they want these coins back to make more loans, so they will have to offer interest-bearing accounts denominated in NewCoins. The interest rate must be enough to pull those coins back out of the market. Banks will have to offer and accept coins at par. That could cause the coin exchanges to collapse. Banks do not discount coins when you go to the bank. When you ask for a dollar, they give you a dollar.

People would move their NewCoin to the banks if the exchanges really came under pressure. Most people buying cryptocurrencies do not care a whit about the distributed ledger feature. Decentralization is a hobbyist's love, not the public's. Suppose you could own a cryptocurrency's value without any risk of losing on the bid-ask spread and earn interest on it. Would you care that the banks are now centralizing the real coins?

The banks would pay interest in order to make the next round of loans. Of course, at some point, they would reach an equilibrium level of loans, deposits, and interest rates, but that is down the line a bit. As banks saw other banks making a profit, they would devote more and more capital to it. The currency's value would tend to stabilize because banks were offering to exchange it at par.

The primary parties that would not participate in the bank money would be those seeking anonymity. They would also be easier to identify for law enforcement authorities because most owners are now getting interest on their NewCoin. Some outside transactions would still be necessary to discipline the banks, just as gold and silver did circulate around the world during periods where we have used metal standards.

The non-bank bid-ask spread would have to widen because most parties would use the banks' costless exchange. Banks would probably totally internalize any mining aspects to prevent theft and other related issues. The only miners would be banks. They would either regulate the others out of existence by holding the majority of the money and changing the charter or use their raw power to shut down external competition. They could take away the value of being a miner.

If a cryptocurrency could be produced in adequate volume to allow a steady-state valuation, even if it did drift over more extended periods of time, and banks offered loans and deposits of it, then its value as a source of anonymous, decentralized money would vanish. Under a fractional reserve system, banks would internalize the exchange, transfer, mining, and de facto ownership of it. We would still have to have externalized ownership of individual coins, but the exchange could be forced to happen through bank servers at a discount or premium.

To maintain external transactions, a person going to a store to buy something that paid in NewCoin would electronically transfer the NewCoin to the merchant. If all the mining was done by the banks, the banks would have brought it inside even though it was "external." Alternatively, the government could grant itself a statutory monopoly on mining all cryptocurrency transactions to protect the banks and prevent conflicts of interest. Within bank transfers, such as when a depositor buys something from a merchant that is also a deposit at the same bank, would drive down mining costs because there is no reason to transfer the underlying NewCoin. The movement would instead happen between line items of the bank's ledger. There is no reason for the bank to transfer it to itself.

Answer 3

The answer is yes. If someone wanted to borrow say 0.1BTC from bank A, then the bank would freshly create an IOU of 0.1BTC and add that to your account. This IOU would be spendable (this may require government decree). So now the Bitcoin money supply has grown by 0.1BTC.

If you used the IOU of 0.1BTC to buy a car from someone than had an account at bank B, then your account at A would diminish by .1BTC while simultaneously the sellers account at B would increase by 0.1BTC and bank A would have to transfer its 0.1(real)BTC to bank B. Now bank B has the asset of 0.1(real)BTC and a liability of owing the seller 0.1BTC.

Given this example one might imagine that the banks would be limited to only lend out (i.e. create IOUs) for as many bitcoin as they possessed originally. But in a more realistic example bank A and B may be making thousands of such loans and there may be thousands of transfers of spendable-IOUs-of-bitcoins between them. The two banks would only need to transfer the net balancing amount of real bitcoin to settle between them at the end of the day. Just statistically, this net transfer will likely be a small fraction of the total money transferred. This means that the total value of bank IOUs of bitcoin can rise to be a large multiple of the amount of real bitcoin held by the banks in the first place.

I have told a story so far in which banks hold some real bitcoin themselves (like reserves) and transfer them directly between each other. Regulators might optionally insist that banks hold their reserves of real bitcoin in accounts with the central bank.

Whether any of this should, or is likely to, happen in practice is a whole other story. This answer was just to illustrate the mechanics in a way analogous to the way fractional reserve banking works today.