Bitcoin cannot replace the banks

For several hours Wednesday, the digital services that the US Federal Reserve uses to settle transfers between banks were offline due to an operational error. Bitcoin holders boasted of the reliability of their payment network, distributed among all the computers that mined coins. Zac Prince, CEO of BlockFi, a cryptocurrency lending company, showed more restraint, noting on Twitter simply that payments via cryptocurrency continue to operate normally. Pay Slik.

One argument in favor of buying and holding bitcoins is that cryptocurrencies will eventually replace banks themselves, as their money transfer and storage services will no longer be needed. This, in turn, will make bitcoins so valuable that they will replace dirty dollars as currency, leaving those with bitcoins in possession of the only real money. Pay Slik.

Holding any asset in the hope that it will turn into money is certainly a long-term investment strategy. But it also shows a misunderstanding about how dollars work and who creates them now. Most of what works as money today in America and in any developed economy does not come from the government. It comes from commercial banks. Banks don’t just hold money or transfer it. They create it.

The misunderstanding about this is so widespread that in 2014 the Bank of England published an article, The Creation of Money in the Modern Economy, to set the record straight. College textbooks teach that banks take deposits and then lend them. This is exactly the other way around, Pay Slik. the BoE explained. A commercial bank decides to make the loan first and then recharges its account balance. That top-up is new credit money.

The so-called fiat money ridiculed by bitcoin supporters is generally defined as a government-issued currency that is not backed by an asset such as gold. But a lot of fiat money, which we use for purposes like paying taxes, is actually a lot of loans, regulated by governments but produced by commercial banks. Pay Slik.

Creating new credit money is good business, which is why, century after century, people have found new ways to make loans. American historian Rebecca Spang notes in her book Stuff and Money in the French Revolution that the monarchy in pre-revolutionary France, to circumvent usury laws, accepted balloon payments from investors and repaid them in annuities. In 21st century America, shadow banks pretend they are not banks to avoid regulation. Loans happen. I can’t stop lending. It can’t be stopped with distributed computing or a gamble of the heart. The earnings are too good.

This is something that Bitcoin investors already understand. Let’s take the example of Prince’s BlockFi. The company is launching a credit card, a joint venture with Visa. The card rewards purchases with Bitcoin instead of airline miles. However, purchases are paid for with a consumer loan, like any other credit card.

Nexo, another cryptocurrency company, will lend fiat cash against Bitcoin, at a loan-to-value ratio of 60%. That loan is new credit money. Similarly, Kraken Financial, a cryptocurrency brokerage, will allow you to trade on a so-called margin account where they will lend you part of the purchase price of a coin.

The language of these companies is revolutionary. BlockFi promises the future of finance. Coinbase, a cryptocurrency exchange that filed an initial public offering on Thursday, wants to create an open financial system for the world. However, what they all seem to actually do is earn fees and interest on loans. They make money on trust credit. Why shouldn’t they? It is a good business.

Bitcoin is turning out to be a good way to bolster the system we already have. There are many things in this system that go wrong. The supply of money on credit can be unstable, as banks stop making loans during a recession, just when people need them most. There is little incentive to extend cheap credit to people who need small loans. But there isn’t much, so far, that Bitcoin seems to have done to fix these things, and it’s not entirely clear how it will do that.

The job of making fiat money better for everyone is just that: work. Regulation of the patient is necessary. You have to go out into the world and meet people outside of the financial system, then encourage lenders to offer products that appeal to them. You need to negotiate a lot with people who make a lot of money by lending money. None of this will happen on its own just because there is a new asset in the world. Bitcoin lenders promise something like a new political party: solid money for the people! However, so far they appear to be just another group of bankers.

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