Is my money safe: There’s a FDIC for that.

One of the interesting discussions I’ve had regarding one of my early blog posts has been around bitcoin lending.

The invention of credit has had great implications for economic prosperity and progress. Arguably, the discovery of gold and similar minerals can be credited to have unleashed significant economic progress. It isn’t the intrinsic value of gold that created this value, but rather gold allowed a mechanism to measure credit.

The benefits of credit are widely apparent. A trader on the Silk Road could take a loan from a wealthy individual and use that to buy goods that he would later sell at a profit in a different country, paying back the creditor on his return.

Bitcoin, by design, is a deflationary currency i.e. it’s value increases by time since the amount of Bitcoin released into the network decreases by time and only 21 million bitcoins will be released.

This is in stark contrast to the money supplies issued by governments. There is no upper limit to the amount of dollars the US Fed can print. There used to be a time when all currency issued had to be backed by a certain amount of gold which did impose an upper limit. The gold system was discontinued to allow for expansion of credit to finance World War 2.

So the key question remains: Does Bitcoin lending occur, and if it does, what is the incentive to lend Bitcoin?

The main argument against the extension of credit via Bitcoin is that, by definition, the motive to lend money is to make a return (through interest). However, in the case of Bitcoin, you make a return by simply holding on to it (value increases steadily due to a deflationary network).

The counter argument becomes pretty simple. At the end of the day, if the return you realize through lending is greater than the return you realize through saving, as a rational investor, you would be inclined to lend Bitcoins. However, the ability to gauge the return you would get simply by holding the asset is wherein lies Bitcoin’s weakness.

The high volatility of Bitcoin makes it especially difficult for an investor to reliably “predict” the return they could expect by holding on to the asset.

Additionally, if you were to setup a Bitcoin lending network like a traditional bank, at any point in time you would have lent more Bitcoin then you have collected from depositors. This is the basic economics of how banks work. For each dollar that some one deposits at the bank, you lend out a multiple of that.

The reason that works is at any point in time, only a small percentage of depositors will ask to withdraw their money.

However, there is risk to that. If the amount of depositors looking to liquidate their assets does exceed the current assets the bank does own, the bank will be unable to fulfill its obligations and will “go under”. A typical “run on the bank”, and the reason why most banks fail.

This is a very important to issue to consider, and brings me to the original title of the post. The US Government ensures every bank deposit in the United States up to $250,000. That is to say, if you had deposits in a bank that went under, the US Government will reimburse you up to $250,000.

The US Dollar, backed by the full faith and credit of the United States Government has a clear advantage when it comes to extending credit.

So does Bitcoin lending occur? Yes – a lot of Bitcoin lending appears to be emanating from peer to peer lending networks where an investor could lend Bitcoin to individuals in economies where interest rates are exorbitantly high due to certain economic and political factors, but it remains to be seen whether it turns out to be a significant source of credit.

Below is an assurance from the US Government at my local Wells Fargo, assuring me my money is safe :).

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