Bitcoin versus "the dollar"
Bitcoin versus "the dollar"
The juxtaposition of bitcoin against dollars is incomplete. I expand on more appropriate framings.
Dear readers,
I hope everyone had an enjoyable Miami conference week, spring break, Easter, and Passover! I’ve been keeping busy and will have some exciting news to share very soon. After all, nobody likes announcing a coming announcement quite like a bitcoiner:
Today’s post is an important analysis of bitcoin as an asset class. How will it evolve over the coming decades, and with which asset classes is it truly competing? The more time I spent thinking about the phrase “bitcoin versus the dollar,” I realized it’s not the most appropriate juxtaposition one can make. And that’s because of one thing: credit creation.
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Fractional reserve banking
Why do I believe that comparing bitcoin to “the dollar” isn’t necessarily appropriate? Start with these two questions:
Can a bank lend dollars into existence?
Can an exchange lend bitcoin into existence?
The answer to the first question is yes. A bank can create money by lending it into existence. This is how fractional reserve banking works. Money creation is a function of loan demand, and that demand is satisfied by entities that have the regulatory permission to create money. The Fed issues banking charters to allow such activity. Our entire financial system, including the issuance of mortgage loans, car loans, and business loans, depends on this process of simultaneous loan and money creation by banks. Here is the image I show my students to demonstrate the idea that money creation is a swap of IOUs:
The borrower is issued credit money, a short-term IOU from the bank. The bank creates for itself an asset in the form of a loan, a long-term IOU from the borrower. The bank only needs to hold a fraction of the total issued credit money on reserve (provable to the Fed), hence the term “fractional reserve banking.”
All credit money that is created by these banks is accepted as “dollars” everywhere in the economy, for example to wire to other banks or to pay credit card bills. This activity is also completely outside the primary function of the Federal Reserve, the keeper of dollar monetary policy, as well as outside the primary function of the US Treasury, the issuer of the dollar itself. In this way, “credit money dollars” and “real dollars” are issued by completely separate parts of the financial system (and on different layers). Now let’s compare that to bitcoin.
Answering the second question, an exchange CANNOT create bitcoin and lend it into existence. In the above IOU graphic, credit money is treated on par with reserve money. This type of relationship does not exist in the bitcoin ecosystem. Any attempt by a crypto exchange to lend money into existence would have to be in the form of another coin or token—and it would take microseconds for any computer to recognize this credit token as an imposter to bitcoin. The credit token would not exist within bitcoin’s network, and any bitcoin node would not acknowledge the transaction as a bitcoin one. So let’s go back to the original juxtaposition: is bitcoin similar to the dollar?