No. There is still 1 BTC in this scenerio. When you choose to deposit your 1 BTC you've lost custody of it and somebody else has gained possession of it. All you have is a promise that you'll get it back - which is not === BTC.
You said what happened to Luna can't happen to BTC because the BTC supply is capped. It's not. The inability to mine new BTC doesn't actually matter. The pseudobanks we call exchanges are still able to introduce numberless BTC into circulation through loans. The result is inflation and possibly market crashes in case of defaults. Really no different from what Tether and every other bank is doing.
Yes, it is. They are not introducing BTC into circulation. This is verifiable via the blockchain.
Banks creating IOU's or derivatives or whatever other abstraction they can come up with never generates new BTC. You'd hope that people foolish enough to work with such financial institutions would know the risk of possessing nothing but an instrument created by the bank. If you're unwilling to take custody of your own bitcoin, you better damn well do some good research on third party custodians.
How much BTC exists in the blockchain is ultimately irrelevant. What matters is the amount of BTC actively circulating.
If you deposit 1 BTC on Binance, then I can get your BTC in the form of a loan. I can even withdraw your BTC. Meanwhile, Binance records still say you have 1 BTC, they even allow you to trade with it. So there's really 2 BTC in circulation. That BTC is duplicated, it's in multiple places simultaneously.
That is correct. And, fundamentally, this is possible because the Bitcoin chain is not the only ledger out there tracking BTC. Each (centralized) exchange has its own internal ledger, tracking how much BTC its customers have.
In the non-blockchain space this is called "credit creation" and it absolutely is something that happens there.
But this doesn't happen with Bitcoin.
It's true that there are a number of DeFi apps that will loan BTC.
However if you look at the loan mechanism it is different to how it is done in traditional finance.
A BTC loan is done in one of two ways:
1) The original owner of the BTC is given an IOU in the form of a different token (lets call it "Wrapped BTC" or wBTC) and the original BTC token is given to the person taking the loan, OR
2) The person taking the loan is given another token ("wBTC"). This is more common.
In both these cases no new BTC is actually created. It's possible to create more of this other token though. In the specific case of wBTC[1] they say it is 1:1 backed with BTC, but other tokens might not have the same backing.
I don't have a strong opinion on the utility of BTC, but I think it is worth being accurate in our discussion.
Exchange has all customer deposits intermingled.
Exchange offers crypto loans.
Exchange shows positive balances across all users that exceed deposits (though may or may not balance out with negative balances).
Everything keeps functioning because the exchange is a black box and not everyone wants to move their BTC at the same time. More people can 'own' BTC on paper than there is BTC in existence on the blockchain.
In the same way that most BTC transactions don't involve the blockchain either, they take place entirely within exchanges.
It's true this is how it would work if you are treating BTC as a traditional asset and creating dollars by loaning the same deposits out multiple times.
But for BTC you can't do this. If they have 100 BTC deposited from all their users and then try to loan out 101 that 101st transaction is impossible because the bitcoin isn't there.
I'm sorry this is just nonsense, as has been pointed out many times, exchanges are not constrained by the blockchain of any particular cryptocurrency, most of their transactions don't take place on a blockchain and their customer balances are not stored on the various blockchains.
You may as well talk about this being impossible with paper money, the bank can't give out more than it has! There are only so many notes! But it doesn't need to. People can trade within the bank and between banks so long as the reserves cover the activities.
Quadriga CX worked this way, until it didn't and everyone discovered their cryptocurrency was fictional.
> I'm sorry this is just nonsense, as has been pointed out many times, exchanges are not constrained by the blockchain of any particular cryptocurrency, most of their transactions don't take place on a blockchain and their customer balances are not stored on the various blockchains.
Sure, within the exchange that's true. The instance the BTC leaves the exchange as a loan or withdrawl it is no longer possible for that BTC.
> Quadriga CX worked this way, until it didn't and everyone discovered their cryptocurrency was fictional.
I don't think this was the case, unless you can show me otherwise.
In particular, they had "BTC ATMs" where people could withdraw cash. Note that this is not loaning BTC.
And when the CEO died, the BTC could not be retrieved. There was no magic second exchange-issued BTC around - it was gone because there is only one copy.
Notably there is a precise accounting of the BTC that was lost because there is a public ledger of it. Quadriga CX didn't produce any more BTC - they just lost their customer's BTC.
> I don't think this was the case, unless you can show me otherwise.
Quadriga CX showed their users having BTC in their accounts.
In reality, the guy running the show had already gambled those away on other exchanges.
It all held together, ish, until he died and the music stopped.
> In particular, they had "BTC ATMs" where people could withdraw cash.
This is news to me and hasn't featured in any write-up of QCX I've ever seen.
> And when the CEO died, the BTC could not be retrieved. There was no magic second exchange-issued BTC around - it was gone because there is only one copy.
Yes, this is exactly what we're talking about - we have no real idea how much BTC is in peoples accounts on exchanges, because they are a black box and may be creating it out of thin air. While they don't try to move too much of it and the exchange remains operational, the ecosystem functions as if those balances are correct.
> Quadriga CX didn't produce any more BTC - they just lost their customer's BTC.
While they were still solvent it behaved as if there were more BTC present. Sure, they didn't create more on the blockchain, but they were able to operate as if there was more.
> While they were still solvent it behaved as if there were more BTC present. Sure, they didn't create more on the blockchain, but they were able to operate as if there was more.
So as I said - they can't lend more than 100% of the BTC they have. They can make up anything want within their own exchange of course.
> that 101st transaction is impossible because the bitcoin isn't there.
The exchange's BTC reserves only matter when customers try to withdraw their coins. Until then, the coins are nothing but digits in their database. They can inflate that number as much as they want.
This might work inside the exchange, but doesn't work if you do a loan outside of the exchange.
In DeFi apps you need an actual token to use. If you don't have a the token you can't do a transaction, and apps choose which tokens they support.
So an exchange can create its own token, say it is backed 1:1 by BTC and lend that. But it isn't BTC so apps have to specifically opt into it.
If they loan out the actual BTC they have in the exchange they can only loan out 100% of what they have (not more) because control and use of each BTC token is dictated by the public ledger which is out of their control.
You can do other things (eg use the BTC as collateral for a dollar loan), but again you aren't lending BTC.
Laymen here: How can they introduce numberless BTC? I thought that was the crux of what makes this different from fiat: you can only transact from one address to another, no institution in between.
This still doesn't change how many BTC are in circulation. When the fractional-reserve imaginary bitcoin implodes, it might even increase the price of actual bitcoin?
> This still doesn't change how many BTC are in circulation.
It absolutely does. I can get a loan at an exchange while the original owners of those BTC still have it listed under their accounts. So multiple people can trade with the same coins, as if they had been copied.
> When the fractional-reserve imaginary bitcoin implodes, it might even increase the price of actual bitcoin?
All bitcoin is "unbacked". There's no intrinsically useful asset behind bitcoin. Your private key is just a bundle of bits. Bits are so abundant as to be worthless.
I know? The point is: neither bitcoin nor fiat currencies are asset-backed. In both cases, there are commercial entities that offer accounts where you can deposit the "thing", and the "thing" is then loaned to someone else, and this is done for some kind of valuable inducement.
The question is: why is one called fractional reserve banking, a behavior that is acknowledged to increase the money supply, and the other one called "oh no this is definitely not increase of the money supply, it's just you relinquishing custody of your bitcoin and why would you do that, there's no reason you'd ever do that".
Actually paper fiat currency is accepted by a government to pay property tax. In this way you need it to keep possession of land, so the entire land value of the linked country, and all the infrastructure built on it, is the backing for 'fiat' currency.
Accepting some form of unbacked currency does not give the currency intrinsic value and therefore make it backed. El Salvador made bitcoin legal tender, which means that USD or Bitcoin could be used to pay property taxes there, that doesn't mean that suddenly Bitcoin is backed by El Salvador property.
> Bitcoin could be used to pay property taxes there
There are no annual property taxes in El Salvador :)
But this may be a technicality, based on the Salvadoran legal definition of the term. So it really depends on what is understood as tax in each jurisdiction.
El Salvador law differentiates between taxes and fees. Taxes are born from an "generating action", like selling a computer generates sales tax. While Fees are born from a "service provided" .
So there are monthly fees payable to the local city/town/village hall based on property size and location for services they provide in that area Some common ones are garbage collection, CCTV, city lighting, road maintenance and the contribution for each City/Town annual Festival. A monthly fee for each town's annual party :O Does that exist in other countries?
So once you get your city hall invoice, and wanted to pay in bitcoin, you'd have to visit the city hall to pay in their bitcoin terminal.
At least four city halls are connected to BitRefill which allows online invoice payments using Bitcoin/Lightning. BitRefill connects to a local payment network, then the user types or scans the Invoice barcode, and makes the bitcoin payment for the fees bill.
Not OP but I figure I'll pitch in because nobody else explained it. When referring to backed vs unbacked Bitcoin (or any other UTxO accounting model based cryptocurrency), the "backing" isn't about whether the token is backed by another asset but rather whether your proxy holding of the token is backed by the actual cryptocurrency on the ledger.
If it's some wrapped Bitcoin that is backed, that means that there exists some UTxO which corresponds to the wrapped bitcoin tokens you hold. UTxO are atomic and unique so you can verify that your wrapped tokens have a 1:1 mapping to the tokens held within the UTxO on the native token's network. Non-backed bitcoin instead are just tokens that are handled through some minting mechanism where there is claimed to be a 1:1 equivalence without any actual tooling to prove that.
This concept of backing can actually even be further extended via Secure Multi-Party Computation where private keys can be collectively held in such a way that no user ever can see the private key but together they can coordinate to build and sign transactions with that private key without leaking it even to themselves. This can then be used to actually hold tokens from a foreign/incompatible network and interact with that network with little to any required trust.
Hopefully that helps answer what is meant.
---
Also since it's often a question asked I'll answer preemptively: "What is UTxO?"
I've mentioned the UTxO accounting model a few times here. Bitcoin doesn't have accounts but rather UTxO or Unspent(U) Transaction(Tx) Outputs(O). These are indivisible bundles of tokens that can only be created or consumed/destroyed atomically. There are no accounts but rather just private/public key pairs which can redeem/spend those UTxO. Additionally, all transactions are just a collection of input UTxO (that are consumed with the tx) and newly created UTxO. All Tx must uphold the rule that the sum of all inputs equal the sum of all outputs (or some equivalent of this rule as is the case for Monero's Zero Knowledge transaction proofs). A number of networks use UTxO or a UTxO extension (such as EUTxO or the cell model). Most famous is Bitcoin but Monero, Litecoin, Cardano, Ergo, Nervos, and a number of other networks also use this model.
This is opposed to Ethereum and co (Polkadot, Solana, Luna...) who use the balance-account accounting model. This model works like traditional ledgers where tokens are stored as some balance in an account and transactions are just transfers from one account to another.
> If someone loans you BTC, the supply of BTC has not increased.
True when someone does it, false when a fractional reserve bank does it.
When someone loans money to someone else, money physically changes hands and there is no concept of a reserve. Banks are able to maintain the illusion of full reserves even though they operate in a state of perpetual insolvency.
So is Binance a bank, when it offers 5% APY Bitcoin savings accounts? Or is it perhaps a shadow bank, which is to say an entity that creates money supply through credit without regulation?
Please explain the mechanism by which a "bank" is able to transfer to you an amount of BTC that they do not have wallet control over?
This is a critical difference. A bank can loan you fiat money that they do not physically have, with the almost always correct assumption that most people won't want to convert that database entry into cash at the same time.
This is not possible with bitcoin. Either the bank has the coins in wallets they control to send to a wallet you control, or they do not and can't.
>Please explain the mechanism by which a "bank" is able to transfer to you an amount of BTC that they do not have wallet control over?
BTC that's in an offline wallet is like cash under the bed; and you're right that no-one is lending money that they have under the bed.
However, a significant number of BTC owners don't keep their money in their own wallets - they keep it at an exchange, which almost certainly commingles it with other owners in shared wallets.
You can certainly take a maximalist position here and assert that the exchange is the real owner, because they have the private keys. The fact of the matter is that the real world includes a difference between legal and beneficial ownership; and has done since well before the existence of fiat currencies - because it's useful.
That still is not the same thing. Coins in an exchange can only be traded for other coins in the same exchange - it's effectively KrakenBTC or BinanceBTC or [...]. Unlike fiat money in a bank, these exchange balances exist only in their walled gardens and cannot be exchanged for goods or services, effectively decoupling them from the total supply.
The total supply of bitcoin is the sum of all unspent transaction outputs on the Blockchain. Not what a bunch of exchanges tell their users they have.
>Unlike fiat money in a bank, these exchange balances exist only in their walled gardens and cannot be exchanged for goods or services, effectively decoupling them from the total supply.
These are demand deposits with the exchanges/shadow-banks. You can (at least with some products; others look more like time deposits) withdraw your deposit at any time. This seems basically the same as a bank account where you can withdraw money at any time to buy goods or services.
I visit my "bank". I deposit my "currency" in a demand deposit account. I receive regular interest payments. My "bank" lends my "currency" to other people, in exchange for interest; presumably making a profit on the net interest margin. I can return to my "bank" at any time to withdraw my "currency".
How is this not credit creation? How is, e.g., Binance not operating as an unregulated shadow-bank without any kind of deposit insurance?
Note that the money supply increases simply as a result of banks not holding full reserves against deposits. Whether the bank lends or not is not important, as far as the money supply is concerned. The same applies to crypto-currency exchanges, of course, which can inflate the circulating supply of bitcoins by lowering the reserve ratio, regardless of whether they engage in lending.
You have to convert your Exchange!BTC into BTC to spend it on goods or services. In other words, it has to hit the blockchain. If it is not on the blockchain, then what is being transacted is BTC in name only.
You need not convert your bank balance into cash to spend it on goods or services. The balance itself can be used directly.
If the bitcoins can be withdrawn at any time (i.e. without a notice of withdrawal), then these deposits are just like a current account, which means they are considered a component of the circulating supply of bitcoins (what we would call M1, if bitcoin was a currency).
> You deposit 1 BTC, they loan it out to someone else. Boom, 2 BTC.
Do you mean "they" purchase a second bitcoin with the second person's loan money? if not, where does the second bitcoin come from? (Hint: think about the blockchain)
Bitcoin is fungible. That Bitcoin doesn’t have to be *exactly* yours but they update their ledger and loan 1 BTC to someone after you deposit your 1 BTC into the bank account. Based on the interest rate of that loan, the bank is giving you a cut in Satoshis. If you choose to withdraw the 1 BTC before the other person’s loan is pid back, they must provide you 1 BTC. They can choose to take that 1 BTC from someone else’s account or use the profits they make in loans and other financial transactions to provide you that 1 BTC.
On the blockchain, there only exists the 1 you deposited, the 1 that was loaned, and the 1 that was generated as profit by the bank. The blockchain tracks these transactions. The bank only has to settle these transactions when someone withdraws and when someone is depositing. Internally, there can be as many or as little transactions are as necessary.
If it is close enough for a real bank in USD, it's probably okay for an exchange in bitcoins, right? If the bank/exchange maintains a 5% reserve, every unit of currency can produce a multiplier/velocity of 20. Bank loans substantially increase the ability of businesses to fund activity.
