Fractional Reserve Banking is Obsolete

In the definitive treatise on Austrian Business Cycle Theory, Money, Bank Credit, and Economic CyclesJesús Huerta de Soto establishes the inevitability of economic crises wherever there is fractional reserve banking. All that is left for monetary scholars to do is analyze past crises and lobby the government to have the right reforms. Fortunately, for the first time in history, we are in the enviable position of not having to wait for reforms that may or may not lead to sound money. I explain why here.

My favorite part about the Bitcoin network is not that it makes society freer, more prosperous, or more just. My favorite part is that it will finally settle one of the longest debates in the history of economics: whether or not money printing and cheap credit are ever needed to stimulate growth.

Austrians know that artificial credit expansion inevitably causes a mispricing and misallocation of capital, whether it’s due to fractional reserve banking alone or in conjunction with a central bank. What is debated is the ethical legitimacy of fractional reserve banking, one side sees lending out deposits as inherently fraudulent while the other sees deposits as an especially liquid loan.

With a deposit, you are improving the custody and safe-keeping of your money and receiving other peripheral services (cashier and bookkeeping services), while at all times retaining the full availability of your money. You are relying on this service to lower the transaction costs of using your gold, silver, or government scrip. A superior service is built into Bitcoin.

  • Mathematically, there is no better custodian or safe-keeper for your money than an encrypted digital wallet. If you use strong passwords, back up your data, and secure your computer, then your bitcoins are safer than your person.
  • Bitcoin is the ideal cashier: it is available anywhere in the world with an Internet connection, it can make infinite amounts of change, and it can transfer money to any account almost instantly.
  • The distributed, unalterable blockchain puts banks’ bookkeeping and check clearing systems to shame.

With this level of perfect security and complete convenience there is no reason to deposit your money with a 3rd party. In other words, bitcoins make fractional reserve banking an obsolete technology, and bitcoin wallets are the best 100% reserve banks conceivable.

As Bitcoin adoption increases we will finally be able to “empirically validate” what Austrians have been arguing for decades: 100% reserve banking with a scarce medium of exchange prevents speculative manias, financial crises, and economic depressions.


What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media. The credit boom is built on the sands of banknotes and deposits. It must collapse.

 Ludwig von Mises

End the Fed: Hoard Bitcoins

The libertarian strategy for undermining fiat currencies has always centered on making gold and silver viable alternatives. This effort has failed because it is impossible to compete against a digital currency, like the dollar, with a physical commodity due to the high transaction costs associated with the latter. The only way metals can succeed is if fiat fails. While it may be the case that fiat currencies inevitably collapse over the long run, waiting for this possibility is unacceptable given the amount of damage that central banks are inflicting on humanity’s accumulation of capital.

The mantra of passing an Audit the Fed bill, miring it in scandal, and “legalizing currency competition” ignores public choice economics as well as the fact that digital fiat currencies have already won the competition against metals and would win it again. We don’t need another political solution to an economic problem, what we need is a more competitive market currency. Enter Bitcoin.

Low transaction costs make Bitcoin the most competitive medium of exchange in humanity’s history, and it may be the case that a currency with even lower transaction costs is theoretically impossible. To learn more about bitcoins I would recommend our excellent Bitcoin Reader.

Transaction Costs

Bitcoin is slowly supplanting metallic and fiat mediums of exchange. It is currently transitioning from the “Innovators” to “Early Adopters” phase:

Innovation Curve

This transition is accelerated by new intermediaries, like Coinbase, that are driving down the cost of selling fiat money for bitcoins. At the same time as demand is increasing, bitcoin inflation slowed considerably due to the block reward halving:

Bitcoin Inflation

The dollar value of all bitcoins in existence now exceeds $300 million:

Bitcoin Marketcap

This leads us to an interesting question: is the value of bitcoins a speculative bubble?

The price of fiat currencies (and the debts denominated in fiat) is the bubble that will burst; the relevant question is when the purchasing power of bitcoins will peak. The appreciation of bitcoins relative to consumer goods will slow down when the adoption rate tapers off and hoarders will use their gains to buy consumer goods. Simultaneously, fiat currencies will be in a hyperinflationary tail-spin and real interest rates will be spiking. High real interest rates will incentivize hoarders of bitcoin to buy productive investment assets and lend to borrowers now unencumbered by fiat-denominated debts. At that point bitcoin’s purchasing power for capital goods (i.e. interest rates) will decline, but the purchasing power for consumer goods will continue to drift higher due to productivity-fueled deflation.

If you’re interested in getting rid of central banking I would recommend hoarding bitcoins by transferring your dollars to (1% fee) and sending the bitcoins you buy to a secure computer. This hoarding sets off a virtuous feedback loop that accelerates Bitcoin adoption:

Bitcoin Feedback Loops

(Flow chart based on Zangelbert Bingledack’s post.)