Velocity and the Death of Fractional Banking/Lending

in LeoFinancelast month


Listening to the recent episode of Unchained where Laura Shin interviews Caitlin Long of Avanti has really put crystallised some ideas that have been floating around my head for a bit. You can listen to the episode below on YouTube, or podcast from the above link. After the youTube embed, I will write what is jumbling around in my head and what is ticking around it!

Many of us have come to crypto to make money in USD or other fiat terms. Many of the tokens and projects are rarely seen for what they aim to do, but are seen more as a 3-letter ticker that will either make you rich or not. I wouldn't be honest if that wasn't also part of my interest in crypto.

However, behind all of this superficial façade of the "successful" influencers and traders is the original ethos of crypto. To fix what is broken in the financial and economic infrastructure of the world and replace it with something that is more grounded in the technology and demands of the present day. It has nothing to do with trading and profits... it is a vision of a future that is enabled by the advantages (and disadvantages) of that crypto brings.

One of the more interesting points that Long points out in the interview is the fact that USDT (or other stablecoins) achieve an M1 velocity that is just orders of magnitude higher than the regular dollar velocity. M1 velocity is essentially a measure of how often a "dollar" changes hands in a set period of time, and is often seen as a proxy for the development status of an economy. The difference between the stablecoin velocities and the fiat dollar is just phenomenal, it's not even close!

In the regular financial and economic system, this relative slowness of the M1 velocity is compensated by the ability to arbitrage on slow settlement times of stocks and loans and so forth. On the stock market, it takes around 3 days for a trade to be settled (money and asset change owneres). I first experienced this a while back... this is in comparison to truly digital assets (like crypto) being settled in the time it takes a blockchain to reach finality (or for probabilistic blockchains like Bitcoin to reach enough finality). This is on the order of seconds/minutes to a maximum of hours for the slower ones. Again, night and day.

This slowness of settlement times means that people can basically re-lend (re-hypothecate) assets that they might technically NOT actually have the ownership of. Case in point, Robinhood and GME. The trading of retail buyers was not a grand conspiracy but the sheer fact that retail investors were NOT EVER directly buying GME (or any other) shares, but the promise (an IOU) from Robinhood. Consequently, when Robinhood ran out of stock in inventory, it would have to go and purchase them on the market... at a hugely inflated cost. Thus, impossible to sustain... so, halt buys.

The length of settlement times enables the profitability of leveraging and fractional banking, which makes up and covers up the fact that the M1 velocity of fiat as it stands is dismal and stuck in the 19/20th century. There is an implicit assumption that not all the owners of IOUs will call them at the same time (bank run), and if a significant amount do, then there is enough time to unravel the mess... unless there isn't. The GME debacle really highlighted this when it became apparent that the amount of implied supply (IOUs) was MORE than the actual stock that was available... across the ENTIRE MARKET!

The infrastructure is old and creaking... and as it starts to interface with modern technology, it will increasingly fracture with events like Robinhood and GME.

This is one of the promises of crypto and blockchain. The ability to KNOW with certainty at ANY point in time, who owns what. The higher velocity that digital native currencies and assets means that all these financial games and trickery can be done away with, and that economies can move back to the actual basic movement of capital and assets as being the prime driver of a developed economy.

Now, I want to make one thing clear.. this doesn't mean that USDT or BTC or any of our beloved assets will be the one that wins. It still could be a Central Bank digital version... all that is required is that there is a true native digital asset. The concerns between a controlled fiat version and a more public version is besides the point in this idea (likewise the inflation or deflationary ideas), there just needs to be something else rather than the infrastructure that currently stands behind the fiat system AT THE MOMENT.

If this was to take place, banks and other financial institutions would be forced to change their current models. A fractional system and re-lending of non-owned assets doesn't work in a system that is transparent and lightning fast. A bank could be insolvent in seconds, with no ability to fufill it's obligations (IOUs).

Anyway... speaking of this, have you checked what amount of your crypto is sitting on exchanges? Remember, these are still the old notion of IOUs. With so many eager treasure seekers hopping aboard in this bull run... perhaps it is time for those emerging from crypto winter to remind people that it is ownership and custody that REALLY MATTER. IOUs are great... until they default and you have nothing.

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I long for the day when fractional reserve banking is a nothing but a dark legacy of economic ignorance looked back upon with scorn and derision.

I do wonder about it though. I'm not convinced that it is a completely bad thing in itself, but when it is so tangled up such that the entire economy and banks are "essential" then there is a big problem.

I mean, the thing is that there's a real question about the degree it's permissible. One thing that needs to be clear is that any bank with fractional reserves needs to advertise the portion of cash assets it has at any given time and be restricted from changing them. The government has a lot of restrictions for this, but they tend to force banks to buy things that are risky with their non-cash holdings.

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