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Comment by b_tterc_p | Hacker News Reader

You give the bank a dollar. The bank loans 90 cents of it to Bob who puts it in the bank too. The bank didn’t invent 90 cents. They’re owed 90 cents from Bob, and they will collect interest on the loan to profit. If no loans are made, the bank will eventually have more than $1.90 in reserves. There is risk here because you and bob might want your money at the same time, or Bob might default, but generally this doesn’t happen at scale.

Now consider Tethers case. You give Tether a dollar. ???. Tether has $0.70 and you’re not even allowed to get it back.

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I think you messed that up a bit.

You give the bank $1. The bank then goes ahead and loans $0.90 to Bob, who then uses it to invest in a business or a home. That $1 still exists, just most of its backed by the debt that Bob has to the bank. I don’t believe bob would take that $0.9 that the bank loaned him and put it back into the same bank.

It’s so frustrating that the crypto folks are basically the antivaxxers of finance. They refuse to understand how it works and yet are sure they’ve got a better plan because the status quo is a scam. At least unlike antivaxxers it’s only their own welfare at risk.

This is what I was thinking but I didn’t have a way to phrase it. Many people are convinced that fractional reserve banking is terrible without understanding the basics of how it work, writing it off as too complicated for people to comprehend and therefore bad... but their solution is a system which is orders of magnitude more complicated and, in all likelihood, will still result in fractional reserve banking entities popping up. Tether isn’t a fractional reserve bank. It’s far worse. It’s just taking your money and showing that that they “only” spent some of it. But people in this thread are comparing it __favorably__ to traditional banks.

I never said that Crypto was any good or that fractional reserve was bad. It obviously works for the banks (until it doesn't), it seems to work for Tether as well.

I'm just pointing out the parallels, which are far more striking than the differences. People here point out that fractional reserves is backed by loans and securities of (supposedly) equal value, or that it's all regulated and insured, but it wasn't always like that, it's not a strict requirement for the system to work.

> but it wasn't always like that,

Insurance and regulation is good for you as a consumer, and yeah that is new.

But assets have always been backed by loans of (greater than or) equal value. That’s the point of banks.

Tether is not a bank. You have no guarantee of being allowed to exchange tether for dollars. It’s just... a weird service that doesn’t make sense. Tether doesn’t “work” because tether doesn’t do anything

> But assets have always been backed by loans of (greater than or) equal value. That’s the point of banks.

Greater or equal face value, not actual value. Tether is basically making the same claim.

> Tether is not a bank.

I never said that Tether was a bank.

> You have no guarantee of being allowed to exchange tether for dollars.

To be pedantic, no such guarantee exists for bank deposits either.

> It’s just... a weird service that doesn’t make sense. Tether doesn’t “work” because tether doesn’t do anything.

Tether obviously does work, it's probably the most stable cryptocurrency out there, despite being run by sketchy people. You can exchange it for other cryptocurrencies and you can exchange cryptocurrencies for ordinary currencies. Absent proper access to ordinary banking, Tether has been a tool for exchanges to perform settlements in the hundreds of millions of dollars. The view that Tether "does nothing" is just uninformed.

From my perspective you’re just justifying tether’s failure to keep its promises by saying it’s not as bad as banks, but also saying it’s not a bank when it’s pointed out how it utterly fails as a bank replacement; when it’s then pointed out that tether doesn’t serve any real purpose and is just a temporary store of value before it eventually collapses, you go back to the fractional reserve comparison.

It also feels like you’re jumping on a worn out bridge and telling me it hasn’t broke yet. Look! It only lost 30% of my money so far!

I'm not justifying anything, I'm making an observation. I don't hold any Tethers nor do I have any intention to do so. I'm absolutely not saying Tether is "not as bad as a bank".

However, as far as a cryptocurrency goes, Tether obviously works even when it's only backed by fractional reserves. Remember, most cryptocurrencies are backed by nothing.

> It only lost 30% of my money so far!

If I held any Tether, I could exchange them right now for dollars almost one to one. That's been true for most of the time of Tether's existence. The peg worked even when it wasn't clear whether Tether had any money whatsoever.

Ponzi schemes also hold value- for a while. Right now, we’re in the while. The peg has worked. It seems unlikely to me that it will continue to work. I suppose that’s the last I’ll say on the matter.

Ponzi schemes also need to produce persistent returns, Tether doesn't. Ponzi schemes aren't priced like free-floating currencies, Tether is.

If we look at the peg carefully, Tether has often traded above one dollar. That's because of Tether's utility as a cryptocurrency. Actual dollars are far harder to move around than Tether. Other cryptocurrencies are backed by nothing and often far more volatile.

The market is certainly pricing in the risk of the fractional reserve, but it priced it so low that it's almost imperceptible. In lieu of any catastrophic events, the peg will probably hold, because it held for the longest time, when it was unclear if there was any backing whatsoever.

The guarantee you can withdraw funds from a bank account does exist, it’s the FDIC. Tethers terms of service specifically state you’re buying funbucks / chuck-e-cheese tokens and they have no redemption value. A unit of value in your bank account represents a claim you have against the assets held in the bank backed by the weight of the US government. A Tether is worth whatever you can get the next guy to buy your bags for representing no obligations on anyone.

> The guarantee you can withdraw funds from a bank account does exist, it’s the FDIC.

Like I said, I'm being pedantic. The FDIC doesn't give you a guarantee that you can withdraw any money from a bank account. It offers you insurance on the amount - up to 250,000$ - in the event of bank failure.

> Tethers terms of service specifically state you’re buying funbucks / chuck-e-cheese tokens and they have no redemption value. A unit of value in your bank account represents a claim you have against the assets held in the bank backed by the weight of the US government.

While I think the characterization of Tether as "Chuck-E-Cheese tokens" is fair, a claim beyond 250,000$ against a bankrupt bank may well be worth 0$, despite the (considerable!) "weight of the US government". In that event, I would probably prefer to have the Chuck-E-Cheese tokens instead.

> A Tether is worth whatever you can get the next guy to buy your bags for representing no obligations on anyone.

While there may be no legal obligation for Tether to exchange its tokens for actual dollars, there still is a reputational obligation to do so, if we're assuming that Tether is intended to run as a legitimate business (which is admittedly a big assumption). In that sense it's somewhat comparable to PayPal.

Haha I think we’re on the same page.

Tether works great in the actual goal: give shady exchanges access to USD without having to do all the KYC/AML it takes to get access to traditional financing.

Actually, their electricity usage makes this everyone's problem, just like antivaxxers.

I’m not sure why this one is getting downvoted. It’s not wrong. Technically bob would probably spend it somewhere and the recipient of bob’s spending would put it in the bank. But the outcome is pretty much the same. I just threw out some bits that didn’t affect the state much.

But for illustrative purposes it’s probably best to assume that the 90 cents is eventually put into the same bank, so people can follow why the bank is allowed to do this.

Well, typically the interest from Bob's loan would be deposited, making the bank's balance go up to a maybe $1.03 or $1.04.

If we’re getting really technical, the interest belongs to the bank as profit. The bank decides to give you a cut of it, which you put in the bank anyway.

> You give the bank a dollar. The bank loans 90 cents of it to Bob who puts it in the bank too. The bank didn’t invent 90 cents.

There are now 1.90$ credited to both me and Bob, where before there was only 1$ credited to me. The 90 extra cents are now part of the money supply. They appeared out of thin air.

Perhaps it's unfair to say the bank "invented" the money, but it did create it.

> They’re owed 90 cents from Bob, and they will collect interest on the loan to profit. If no loans are made, the bank will eventually have more than $1.90 in reserves.

If Bob eventually pays back and the bank doesn't make any further loans, the bank will have 1$ (my dollar) and a couple of cents of interest.

> You give Tether a dollar. ???. Tether has $0.70 and you’re not even allowed to get it back.

If I give Tether a dollar Tether has another dollar. I get a Tether token which I can exchange on the open market for whatever the market price is. It supposedly is possible (though inconvenient) to get Tether itself to exchange their tokens for actual dollars (of which they hold only 70%) but (just like a bank) Tether relies on that not happening "at scale".

"There are now 1.90$ credited to both me and Bob, where before there was only 1$ credited to me. The 90 extra cents are now part of the money supply. They appeared out of thin air." I think you are confusing money supply and record keeping. The only spendable money is what bank actually has so if you and Bob where the only customers of that bank and bank loaned 90c of your 1 dollar to Bob the only money you could spend would be 10c. The only bank that creates money out of thin air is FED.

This is not true. You can spend up to a dollar, because you’re spending from your bank account and everyone trusts that you’re allowed to take up to a dollar. Dollars a fungible, so you’ll be taking someone else’s dollar, but that’s ok, because not everyone needs their dollar at once.

Bob can spend 90 cents because he has 90 cents, though he is obligated to pay it back later.

The bank can loan out (in this example) 81 cents of the 90 cent deposit from bob.

Do you understand what run on the bank is ? Do you understand a difference between physical world and a theory that is used for macro economic modeling? Because majority of people are under FDIC limits and basically attribute 0 counterparty risk when dealing with their own bank the net economic effect can be modeled using a theory that you are quoting in very simplified terms. Any given bank can only operate using deposits they have not loaned out if they run out of that FDIC will take over (greatly simplifying obviously banks can borrow money against their assets, loan portfolio etc.). So in real world terms the only bank that creates money out of thin air is FED.

That isn't true. You might want to take a look at this:

https://en.wikipedia.org/wiki/Money_creation#Fractional_rese...

You might want to take a look at types of calculations that theory is applied to. It's used to model macro economic effects which has very little to do with what people imagine this means.

The Fed is not the only bank who can loan funds at a fractional reserve. You might want to read a bit more about how banking works.

Fractional reserve does not create money it just specifies what % of money a bank can loan out.

https://en.wikipedia.org/wiki/Money_supply

> If Bob eventually pays back and the bank doesn't make any further loans, the bank will have 1$ (my dollar) and a couple of cents of interest.

This is wrong. The bank will have $1.90 + interest. You have to pay back your entire loan. Yes, bob might default, but averaged out, the risk calculations set the interest rate high enough to cover that profitably. The fractional reserve part of the banking system is a temporary choice that happens continuously. But if stopped, the bank would eventually have all of its cash because it has all of its reserves covered in debt.

> If I give Tether a dollar Tether has another dollar. I get a Tether token which I can exchange on the open market for whatever the market price is. It supposedly is possible (though inconvenient) to get Tether itself to exchange their tokens for actual dollars (of which they hold only 70%) but (just like a bank) Tether relies on that not happening "at scale".

The difference is tether has no title to the missing 30%, and probably even more of it if we are going to be honest. The likelihood of repayment and the fullness of reserves are two separate concept. And banks win on both counts.

> This is wrong. The bank will have $1.90 + interest.

Dude, check your damn math! The bank owes me a dollar. At the time of the loan, it has 10 cents and Bob has 90 cents plus an obligation to pay it back with interest. At the end of the loan, the bank has the 90 cents back plus some amount of interest nowhere near enough to make the total add up to $1.90 (unless Bob takes up a ridiculously high APR and term just to loan a dollar).

> But if stopped, the bank would eventually have all of its cash because it has all of its reserves covered in debt.

This ignores that Bob has deposited his money at another bank which has used it as a reserve to make even more loans. The system can't stop, it would collapse.

> Dude, check your damn math! The bank owes me a dollar. At the time of the loan, it has 10 cents and Bob has 90 cents plus an obligation to pay it back with interest. At the end of the loan, the bank has the 90 cents back plus some amount of interest nowhere near enough to make the total add up to $1.90 (that would be a ridiculously high APR).

Assume that “the bank” in question represents all banks. And so depositing in any bank counts as depositing in “the bank” because this is illustrative.

You give a dollar. The bank loans out 90 cents to bob. Bob buys something (I skipped over this) from Joe. Joe puts 90 cents in the bank. Bob pays back 90 cents he earned using the purchase from Joe. The bank now has $1.90.

You’re right that the system would collapse if it stopped. But so would, say, the entirety of the national economy stop if we decided to just stop making loans. We like loans because loans enable growth. So you can, idk, buy better GPUs to mine poopcoins

> Assume that “the bank” in question represents all banks.

"The bank" can't simultaneously be "all banks". Sure, if we consider "all banks" then $1 paid into the system can "magically" turn into $1.90 (and far more) without even considering interest. That's my original point! Money is being created by fractional reserve banking.

https://en.wikipedia.org/wiki/Money_multiplier

It doesn’t matter which bank the loan is deposited into. That doesn’t affect what’s happening here. I’m saying one bank because it’s easier to understand. If you really want to be pedantic, sure, maybe bank 1 has $1 + interest and bank 2 has $0.90. That’s also possible

But it’s important to get that money is not blindly created. It’s done because value is created at a faster rate than physical dollars. You can view banks as a service that invests your dollars. You give them money to loan out and receive some of the interest in compensation. You yourself can create “new money” by making a loan yourself. The new money is just the result of value creation.

> It’s done because value is created at a faster rate than physical dollars.

[citation desperately needed]

I think you're just letting your imagination run wild on how things work and why that makes sense.

> You yourself can create “new money” by making a loan yourself.

No I can't. If I make a loan to myself, there is no new money to circulate. If a bank makes a loan on fractional reserves it is new money than can circulate and that can itself be the basis for new money creation.

> The new money is just the result of value creation.

The new money is the result of fractional reserve lending, period. Whether "value" is created along the way is absolutely not a given.

> I think you're just letting your imagination run wild on how things work and why that makes sense.

If value were not being created fast enough, then people wouldn’t be able to payoff the loans. The loans are made either to enable value creation (business loans) or to fund a purchase and the loan taker agrees to funnel their value creation (salary) back into it.

> No I can't. If I make a loan to myself, there is no new money to circulate. If a bank makes a loan on fractional reserves it is new money than can circulate and that can itself be the basis for new money creation.

Obviously I meant to someone else. Though perhaps this one is too hand wavey to be useful

"No I can't. If I make a loan to myself, there is no new money to circulate. If a bank makes a loan on fractional reserves it is new money"

If that was true, that every loan by a bank was multiplying assets by 10, because they're required to hold 10% in reserves, then we would instantly have runaway unimaginably huge inflation and everything would collapse. So even if you don't understand why it's not true, common sense should make you pause and look for that understanding.

> If that was true, that every loan by a bank was multiplying assets by 10, because they're required to hold 10% in reserves...

It is true. Assuming that banks are exerting their full capacity for lending, banks would be multiplying the money supply by 10.

https://en.wikipedia.org/wiki/Fractional-reserve_banking#Mon...

> ... then we would instantly have runaway unimaginably huge inflation and everything would collapse.

That isn't true. If you get loan to buy something, that isn't free money. You're going to have to not buy other things to pay back the loan.

You're saying it's free money for the bank. So the banks would have all the money and nobody else would have any and the economy would collapse.

Look, how do you know you're not the equivalent of a flat-earther? Is there any doubt in your mind about whether you have correctly understood the situation? When did you become convinced of your views?

> You're saying it's free money for the bank.

I never said anything like that. I'm saying the bank is creating new money that is becoming part of the money supply. I gave you a Wikipedia link so that you can convince yourself.

> Look, how do you know you're not the equivalent of a flat-earther?

Wikipedia says what I am saying.

> Is there any doubt in your mind about whether you have correctly understood the situation?

That is a question that you really have to ask yourself.

Do you think banks destroy money?

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