What percentage of people do you think realise how modern banking works? In my experience when I talk to people, universally the answer is "they take money from Alice and lend it to Bob, the difference in rates is how they make money".

I wonder if a survey about this has ever been done, but I suspect only a very small percentage of people really realise that banks, private banks, simply create the money they loan you themselves, as they wish.

Reminds me of that quote: "if the average man realised how our banks work, there would be revolution in the streets tomorrow".

I've worked at a bank. A significant proportion of the the workforce had no idea how it works. I'd say <10% of the senior executives have the slightest clue.

But it's not 'as they wish' as you say, depending on where they operate, they are typically constrained by capital and liquidity ratios set by their regulator.

Isn’t bank capitalization largely bank stocks, which are valued largely on the number and performance of originated or otherwise held loans?

I feel like I have a pretty solid grasp on the operational mechanics of money creation, but I don’t for capitalization. The whole thing seems a little dippy though. For example isn’t the Fed “capitalized” by its largest borrower, the Treasury?

All that being said I doubt loan officers check their capitalization ratio before originating a profitable loan to a creditworthy borrower. I imagine another department checks the ratios from time to time and sells or resells loans for cash or stocks to increase the capitalization ratio as needed. I’d love to hear from someone who actually handles this.

OP was talking about financial capital. Financial capital is the difference between assets and liabilities. If the company was liquidated right now, what would remain is the financial capital, so in a manner of speaking it's the net worth of a corporation. Regulators require banks to keep a certain amount of financial capital in accordance with the risks that they take and various other parameters in order to make sure that they are able to absorb big losses without going bankrupt.

Yeah, I'm aware of the basic investopedia definition. What I don't understand is what are those assets exactly? What kind of assets can be counted as capital? Vault cash? Reserves held at the Fed? And is a performing loan capital? It's an asset that can be sold to other banks. If that's the case, then can't a bank increase its capital by originating good loans? If that's so, then capital requirements don't particularly appear to operationally constraint loan origination and deposit creation.

I think something is very wrong, when the base of the economy - money - is so complicated, that only few people understand it. This just gives room for fraud and bad conspiracy theories (the jews control all the money! .. so I heard couple of times)

But a better alternative? Well, cryptocoins are not exactly simple either(despite their other flaws). And most other concepts I have heard of, are hellish in the details, too.

Solana made me interested in cryptocurrency because it is actually possible to use it as a medium of exchange in theory. I say in theory because a volatile cryptocurrency isn't exactly what I have in mind when I think of a currency used for payments and business.

There is RAI which is an algorithmic stablecoin on Ethereum which fails to scale.

I can imagine a world where in 10 years people figured out how to build a price level targeting cryptocurrency with neither inflation nor deflation on a platform which is fast enough to process every day payments and which people in developing countries adopt to minimize volatility and avoid inflation in their national currency.

Those days are far into the future and they have absolutely nothing, nothing to do with Bitcoin. Maybe Ethereum if they solve the scalability problems. Maybe Solana if they build a RAI inspired stablecoin. Maybe a completely different platform but certainly not Bitcoin.

I'm not sure what you're saying here. You basically made the point that these other technologies don't work (especially Solana, which is a centralized mess that has required multiple network halts to fix issues), but for some unspecified reason Bitcoin isn't the solution (despite working exactly as intended for ~5000 days straight now without interruption).

Can you explain it to a child? I studied IT and I followed the whole thing and I barely understand it.

> I followed the whole thing and I barely understand it.

What don't you understand?

I do understand the basics. Enough to understand, that most who do talk about crypto, do not understand at all, what they are talking about. (not directed at you)

And I could not explain the concept of cryptocoins to children either. Nor adults actually, unless they have a background in math.

I mean the concept of the blockchain, allright. Even people who do not know cryptoalgorithms can get it. But mining coins? You can mine gold, that is understandable, but mining numbers? How do you explain that in simple terms?

> But mining coins? You can mine gold, that is understandable, but mining numbers? How do you explain that in simple terms?

Similar to how mining for gold requires repeated strikes of a pick to reveal nuggets of gold, "mining for Bitcoin" requires repeated attempts to guess a random number (strikes of a pick) which has a shifting difficulty due to how many miners are trying to do the same thing (not unlike an increased difficulty of finding gold when there are multiple miners prospecting in the area).

Assuming you didn't trade for/buy it off of someone, having a Bitcoin is analogous to having a gold nugget in that it proves you did the work (proof of work) to get it (picked at rocks, or, expended the necessary computation cycles to guess the correct number/nonce).

Edit: Just like the amount of gold in the world is dictated by how much has been mined, the same analogy plays out for Bitcoin. The only difference is that the maximum amount of Bitcoin that can be mined is known and enforced algorithmically whereas physical gold is a guess/estimate.

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In terms of explaining it to others, they don't need to understand all of the technicals to "get it." People don't understand (technically) how their iPhone works but they "get it" and are able to use it.

"having a Bitcoin is analogous to having a gold nugget in that it proves you did the work (proof of work) to get it (picked at rocks, or, expended the necessary computation cycles to guess the correct number/nonce)."

It is really not analogus. A gold nugget is something material, with a practical value. You can make electronics or jewelry out if it.

But some random "mined" numbers? Why do they have value? They don't. Unless others accept their arbitary value. Which to me is not much different, than fiat money.

It somewhat works, if people accept the weirdness of the concept, but a intuitive understanding of value, like with gold, I cannot see.

> But some random "mined" numbers? Why do they have value?

The random mined numbers are not where the value is stored. Those numbers just confirm that the miner who finds/guesses that number did the necessary work to find it, and in turn, validate the authenticity of the current block of transactions. Their reward being Bitcoin for doing the work (how Bitcoin comes into existence).

That Bitcoin has value because it represents energy or work expended, just like any currency—dollars, vodka, whatever. That's the whole reason any currency exists: as a medium to trade value generated by one person's work for the results of other people's work. Instead of physical labor, though, the work being done is computation.

It also has value because of how the underlying system that backs it works. In fiat systems, the rules about how much money is in existence, who can or cannot access the system, and the ability to accumulate savings is dictated by a central authority. With Bitcoin, there is no central authority. The amount of Bitcoin produced cannot be changed without fundamental changes to its halving algorithm which would result in a fork of the network, creating a brand new currency (with the original network continuing on uninterrupted by people who disagree with the new rules).

This is another reason Bitcoin is valuable: everything is driven algorithmically by consensus, meaning, humans can't alter it on a whim (like a fiat system). Instead, the only way to make a change is to propose it in the form of a code patch and then have the rest of the network accept that change. If the network doesn't accept it, the change doesn't occur. In terms of money, there's never been a more valuable form (there is no analog for a form of money that doesn't require human trust—Bitcoin is unique in that category).

Beyond that, it also has value because it's digital and permisionless. I don't have to get a bank's permission to do business or transact with someone else. I can just _do it_. And I can do that on a global scale, instantly. Contrast that with the existing system, any amount over a few thousand dollars triggers red flags, transactions get blocked, and insane amounts of time and energy get wasted just for you to get access to your money (that most people don't view that as patently insane proves how well the conditioning works).

Even further, Bitcoin isn't something that can be confiscated (like fiat, precious metals, or other assets). This means that corrupt governments and individuals can't just blindly steal from you. The only way to get your Bitcoin is to get access to your private keys. The only way to get those is, ultimately, by force/violence (i.e., they can't just dip their hand into your bank account and clean you out because of a "law" they invented). And that only works if your private keys are accessible—though difficult, you could memorize them creating the ultimate security system.

The best part and why Bitcoin is extremely valuable: its base cannot be inflated. Meaning, when I work and earn money, that money either retains its current value, or, increases in value. There's no potential for a government to randomly print off trillions on a whim and devalue the money I've already earned (essentially, stealing my life from me covertly).

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All of the above is radically different from fiat money. Again, we've never had a currency like Bitcoin in the history of humanity (in part, why it's so difficult for people to understand it). It's like showing fire to cavemen.

Bitcoin is pretty simple to understand.

In part, I think that is why so many criticize it.

I am a big fan of BTC and crypto and I see plenty of valid criticism. But most of it sounds like people wishing they got in at the beginning when it was offered to them. So now they must wish for its demise to counter.

Technically speaking, you can do this. For example you could create a private VC firm and convince people to give you their money. You could then "loan" that money to a start-up. That start-up would then pay its employees with the money who could re-invest it with you. You take that money and "loan" it to another start-up. Voila, you've created capital.

As soon as you start taking other people's money you are subject to a ton of regulations for limiting fraud. In the above example if you took the funds and bought a house you'd be potentially guilty of fraud.

That has 0 to do with what I said, please re-read.

I don’t see the problem here. Creating money isn’t free for private banks, they can’t do it as much as they want. They start rejecting more loans when funding gets tighter.

What is the concrete problem that this system creates in your opinion?

Several problems. First, it has been amply demonstrated that (1) the rules aren't as tight as should be and (2) the "punishment" for failure is not strong enough, or should I say, it is non-existent. This means that banks can and will make too risky investments, collect the profits when they succeed, and get bailed out – with no personal or corporate responsibility of any kind – when they fail.

Second, this creates a class privilege: while banks can create money at will (and profit from it) as long as they stay within the confines of the regulations, ordinary families and individuals have no such power. There is no mechanism whereby ordinary people and families can do something equivalent to free leveraging through money creation, given similar capital/reserve minimums rules as banks have. Unlike a bank, a person with 10k$ cash on hand cannot credit themselves 100k$ (or 200k$ or 500k$) of money and use it as they please, to spend or to invest. In fact they have to go through the very same middlemen who do *have that kind of power, and which do use that mechanism to credit themselves the money that they will lend you for interest*. This doesn't strike me as fair.

> First, it has been amply demonstrated that (1) the rules aren't as tight as should be and (2) the "punishment" for failure is not strong enough, or should I say, it is non-existent. This means that banks can and will make too risky investments, collect the profits when they succeed, and get bailed out – with no personal or corporate responsibility of any kind – when they fail.

The problem in 2008 was subprime loans that should never have been allowed, it wasn’t that banks could create enough money. Inflation after Covid was caused by central banks, not private ones, and it was done on purpose to avoid a recession. I don’t think these things are inevitable consequences of private banks creating money.

> Second, this creates a class privilege: while banks can create money at will (and profit from it) as long as they stay within the confines of the regulations, ordinary families and individuals have no such power.

Banks are given that privilege in exchange for being regulated to hell. They get a kind of monopoly over these profits in exchange for doing things like being forced to bank everyone, including unprofitable customers. Without this incentive, who would do the banks’ job?

Hong Kong makes this more obvious by letting banks issue paper currency: HSBC, Standard Chartered and Bank of China all issue their own banknotes, with radically different designs to boot.

Northern Ireland and Scotland do this too, but there it's kind of obfuscated by both being interchangeable with the British pound, while the HKD stands alone.

That's the history as well, individual banks used to issue paper notes which were redeemable for something "real" (gold in the vault). This evolved to the system we have today where they did away with the gold.

Something like 95% of money in circulation is money borrowed from future. Only a small fraction money in circulation is already earned money.

>>private banks, simply create the money they loan you themselves, as they wish.

I for one did not realize that. I thought that was what the single nation's central bank does. If strictly true, how does anything work, I. E. Why would they not just create money ad infinitum? I imagine there are crucial, critical details to that "simply".

they have to buy banknotes from the central bank and there is a "reserve ratio" which determines the ratio of how many "banknotes" they own and what they can create.

More or less.

What people tend to forget is banks are just "middlemen" - they are a mechanism to facilitate trade and not much else.

Only tangentially related, but let's not fall into the fallacy of the middleman -- middlemen are only bad if they are legally or otherwise monopolistically required to be there. In other situations, they add value in the connecting of producers and consumers.

What value or service are they providing, and which "producers" and "consumers" are they connecting? In fact, they do have a monopoly wrt. their customers: they can credit themselves assets by creating a matching liability – inside the confines of regulatory limits – while ordinary people and businesses can't, and thus they have to pay the bank a fee to do that for them and give them the money.

You mean like banks are? I don’t think I can call up the national reserve bank and get a loan to buy a house.

Central banks are not in the business of banking.

1. There are no longer any reserve requirements in the US, UK, Canada, and other places. EU reserve requirements are 1%. Banks are instead constrained by capital requirements nowadays.

2. What value or service does this middleman provide? Why can't businesses and families and individuals get money by crediting themselves the money and creating a matching liability? This is what banks do.

1. Because they are all bankrupt/technically insolvent and trying to inflate and fight their way out of their debts to Russia, India and China.

2. Mostly pensions and pension funds - saving work now for payments later when you can't work - see 1.

2a. Additionally funding large projects which no one individual/institution can afford no matter how wealthy, such as building huge infrastructure projects like silk road and other national infrastructure. See 1.

There's another layer to the onion. You mentioned the small number that understands the fractional reserve system. What percentage of those know that in 2020 the reserve ratio was set to 0, so banks don't even have to legally have any reserves to poof money into existence.

I have heard this, and I believe it, but if taken at face value, it would mean that some bank could, right now, simply poof 100 trillion trillion trillion dollars into existence, and then start giving it to random people. If the people who control the money-poof-button at some bank were to do this, would there be any way to stop them? Or would they somehow not be able to in the first place?

The reason the fed lowered the reserve amount to zero is because it was no longer a real barrier to lending. Since 2008 US banks had amassed something like 4 trillion in liquid capital and were lending at the same or reduced rates. There was also a currency shock due to the pandemic. The search term is “ample reserves regime”.

The fed still has other requirements for use of their facilities and every bank that lends money is covered by a wide swath of regulators that have their own asset to liability and loan makeup requirements.

Sooner or later part of these 100 trillion trillion dollars will be withdrawn from the originating bank and deposited with other banks. The originating bank will have to send reserves to these other banks, and if it can't because it doesn't have enough reserves, the bank will fail.

But the reason most countries no longer have reserve ratios is because these ratios have been replaced with capital requirements, which likewise constrain bank lending activity. Apparently some people didn't get the memo though, and think banks are now unregulated and can do whatever they want. In reality the banking sector is one of the most regulated industries, and for a good reason.

So it states:

"This description of the relationship between monetary policy and money differs from the description in many introductory textbooks, where central banks determine the quantity of broad money via a ‘money multiplier’ by actively varying the quantity of reserves.(3) In that view, central banks implement monetary policy by choosing the quantity of reserves. And, because there is assumed to be a stable ratio of broad money to base money, these reserves are then ‘multiplied up’ to a much greater change in bank deposits as banks increase lending and deposits. Neither step in that story represents an accurate description of the relationship between money and monetary policy in the modern economy. Central banks do not typically choose a quantity of reserves to bring about the desired short-term interest rate.(4) Rather, they focus on prices — setting interest rates.(5)"

Does that mean the whole "Fractional Reserve Banking" explanation is not how it works?

FRB isn't how banking has ever worked, even when we used commodity money, but it's a relatively simple concept that matches peoples' intuitive sense of money as a fixed amount of tokens used to store wealth. But money's purpose is to facilitate transactions and be a unit of account which should be thought of through the lens of double-entry accounting, something almost nobody does.

Banks would always have tracked accounts via ledgers though, it's just that before fiat currencies they had reserve requirements in place to ensure banks kept enough currency on hand to handle day to day withdrawals.

So is an explanation like this just incorrect? Or an oversimplification?

https://www.investopedia.com/terms/f/fractionalreservebankin...

Genuinely curious!

From the article you linked:

> This is not how money is actually created but only a way to represent the possible impact of the fractional reserve system on the money supply. As such, while is useful for economics professors, it is generally regarded as an oversimplification by policymakers.

And from the Bank of England's (very good) primer on money creation:

> Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits.

> ...

> Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits

The "money multiplier" concept of FRB is a useful model in the same sense that modelling an atom as if it were like a solar system with a solid nucleus with electrons whizzing around it like planets i.e. not really 'true' but a useful-enough approximation for many use cases.

The BoE primer explains all of this very clearly on the first couple of pages, it's well worth reading:

https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

It's still true that reserves are only a small fraction of deposits, so the part about calling it fractional reserve banking isn't incorrect.

But the Bank of England explanation is a lot better.

The reserve ratio is one limiting factor among several that affect to what extent commercial banks can expand the money supply. For many decades leading up to the 2008 financial crisis, banks (in the US at least) extended loans up to this limit basically at all times, holding almost no excess reserves. Since then, they have not, and recently the Fed removed the reserve ratio requirement altogether: https://fred.stlouisfed.org/series/EXCSRESNW

I think what they're trying to say is that although in economic theory central banks are thought to control the quantity of money, in reality they control the price of money. (They can't control both the quantity and the price.) My understanding is that whether they set the price or the quantity of money via monetary policy is a sort of implementation detail that shouldn't make any difference, although I'm by no means an expert.

Yes, Bank of England's explanation is the place to start. If you don't understand banking then you don't understand money, and most people don't understand banking.

One thing I'd love to read more about is how banks, larger and smaller ones, handle liquidity outflows. Do banks have to cooperate to ensure that transfers caused by loans - e.g. customers paying for equipment with a transfer to another bank - mostly net out between them and the "real money" mostly stays within the system?

Having worked in a GSIB Treasury I can answer this: In short banks do not co-operate, they are completely independent of each other. To manage liquidity they project all their expected outflows and inflows over a variety of time horizons under both normal and stressed conditions (capturing everything - cc purchases, drawdowns on overdrafts or other credit facilities, deposit movements and transfers, mortgages and other loans, refinancing of funding, debt issuance, staff and building costs etc etc etc, there's a huge amount of modelling behind this). Under US or UK regs Banks have to hold large liquidity buffers, in the UK this is enough to finance 2 months stressed outgoings assuming no incoming. It's pretty punitive, and runs into the 100s of billions for big banks.

Thank you :) Sounds like a hell of an optimization problem, since there are not only many variables to model, but also many ((risk) allocation) decisions to make!

When a bank considers giving a loan, can it model where the money would/might be eventually transferred to - whether it would stay on the bank's books and thus require less liquidity to cover net outflows?

I have the impression that central banks try to model national economies via "flows between large groups of actors", do commercial banks analyze/simulate this too on a (smaller) scale, to find out how not only money flows between them and other banks, but within itself too? Since accurate models would result in more profitability, is it safe to assume that banks have the best economic "world model"?

When I buy groceries, I have no idea where the money ends up even in the next "step", maybe banks attempt full "network simulations"?

Regarding the cooperation/net flows, wouldn't a more "symmetric" banking system be able to create more credit? https://github.com/void4/notes/issues/73