Chapter 15: Bitcoin Banking

Banking has two core functions: holding deposits and allocating investments. The need for these two specialized services is not the result of technical shortcomings of government money that bitcoin could improve upon. They are demanded in a free market for the same reason any good is demanded: consumers value these services, and providers specializing in them can offer them at a lower cost and higher quality than individuals could provide for themselves. There is a lot that is wrong with crony-capitalist modern banking, but this is primarily the result of government protection of banks that allows them to profit from unproductive practices and offload the downside risk of their activities to taxpayers. The demand for legitimate banking services will continue to exist under a bitcoin standard, just as it has existed under other forms of money. Bitcoin block space does not replace the two essential functions of banking.

Most people with appreciable liquid savings prefer to have most of their savings deposited with a specialized service that can ensure better security. The value of keeping large amounts of cash in a bank vault protected with firearms rather than under a mattress is obvious. Individuals do not want to always have physical possession of their entire life savings because of the risk of loss or theft, and the stress that comes with it. Homes are not designed to optimize for securing large amounts of physical money, but bank vaults are. It is an inevitable part of human trade and specialization that enterprising individuals would take the initiative and build a facility designed for securing stockpiles of money. Such a facility would employ the kind of security that is unsuitable for a residential home. Individuals would then benefit from paying a small cost to have their money secured at that facility.

Bitcoin allows people to send money globally without censorship, but it cannot possibly offer them safe and reliable self-custody. That is an inescapably real-world, flesh-and-blood problem. The same censorship-proof nature of bitcoin that allows the sender to irreversibly move money across the world can be misused by a thief to permanently steal someone’s bitcoin. The nodes of the bitcoin network have no way of distinguishing between different people wielding a private key, and no notion of legitimate or illegitimate ownership of these keys. Even absent theft, hardware wallet passwords can be forgotten and backup codes lost. Expecting bitcoin to end humans’ demand for custody solutions is entirely unreasonable.

It is also inaccurate to assume that the continued existence of banking under a bitcoin standard will necessarily result in censorship, inflation, and fractional reserve banking. Any industry functions well only when a free market exists that gives consumers a choice in their providers; this choice forces providers to either care for their clients or suffer the penalty of lost customers and potential failure. The evils many associate with banks may be more accurately understood as originating from centralized governments and the lack of free-market choice. The problem with banking, then, is not the nature of banking itself but government policies that create monopolies. In a free market, banking would continue to exist but would be subject to consumers’ choice and satisfaction.

Many bitcoiners may want a world in which everyone gets to be their own bank, but most people do not want this any more than they want to be their own butcher, builder, car maker, or baker. To impose this model on everyone is impossible due to bitcoin’s permissionless nature. There is nothing one bitcoiner can do to another bitcoiner who decides to sell custodial claims on the bitcoin their own.

That the benefits of bitcoin are lost to those who choose to deal with custodian services is also inaccurate. One may lose the censorship resistance and permissionless control of owning their own bitcoin private keys, but they would nonetheless benefit from holding an inflation-resistant hard asset. While there is demand for a permissionless way to send value worldwide, that use case is without a doubt dwarfed by the universal demand for the hardest money. Not everyone has a pressing need for making payments their government does not approve of, but economic reality will inevitably compel everyone to converge on the hardest money in the market. As time goes by, and if current trends continue, we can expect demand for holding bitcoin as a hard money to increase even while more transactions are priced off-chain on internal ledgers held by bitcoin-based banks.

The second core function of banking is the allocation of capital into investments. The demand for this function is also not something bitcoin can eliminate. The development of banking institutions is an advancement in capital accumulation, allowing for a much more sophisticated division of labor and higher productivity. Because bankers specialize in the deployment of capital, they allow individuals to specialize in their respective fields and focus on being as productive as they can. The individual is freed from the labor of analyzing various investments and assessing their possible returns and risks. This task is delegated to professionals who specialize in matching individuals’ investment goals and risk tolerance with suitable investment projects. The allocation of investment is an act that cannot benefit from the automation and immutability that bitcoin provides to financial transactions. These are activities that require a human judgment of factors outside of the bitcoin blockchain and would exist in any sufficiently advanced capitalist economy. This part of banking would also exist on a bitcoin standard.

Bitcoin cannot replace banks, but its monetary properties will lead to a banking system significantly different from one built around fiat. Here are seven ways in which we can expect bitcoin’s monetary properties to influence a bitcoin-based banking system.

Savings Technology

Chapter 5 surveyed the historical evolution of the technologies used to fulfill the function of savings. Up until the nineteenth century, people would save in physical silver or gold coins. Then came the savings account, where the saver would hold government money that was backed by gold. Based on hard money, the saver could reliably expect these instruments to hold their value for the future. Everyone from a child to a pensioner could store their wealth in a medium they could hold for the future or carry anywhere in the world. But as governments eroded the gold backing of the money over the twentieth century, the ability of bank savings accounts to keep up with inflation disappeared.

To store value into the future, investors had to shift to buying government bonds. The demand for bonds as savings drove the enormous bubble in government debt worldwide, far beyond what governments’ creditworthiness would support. This brought down the yields for savers, and as inflation continued, the returns on bonds could no longer keep up with it. Savers needed to take more risks with their capital to simply preserve their wealth. The stock index fund appeared as the saving vehicle of choice in the 2010s as bond yields continued to plummet and enter negative territory. After the coronavirus crisis of 2020 and the significant monetary intervention by governments and central banks worldwide, bond yields plummeted significantly, and investors have little choice but to take on more risk simply for capital preservation.

Ideally, one wants to save their cash balances in the instrument with the highest degree of salability across time and space. Fiat man faces a complicated problem here, as none of his potential choices has good salability across time and space. A dollar in a bank has great salability across space, allowing the owner to send it across the world in a few days, but it has terrible salability across time, making it unwise to hold large positions in it for the future. Fiat man thus must actively manage his cash balance between a part he uses for sending payments across space, and a part he saves for the future. This is an expensive balancing act that impedes individuals’ ability to plan and reduces the utility of their cash balances in the present. The demand for saving is currently being met by a variety of suboptimal instruments: bonds, real estate, gold, art, and equities. To save and hold a cash balance, one needs  to perform complex calculations to decide an allocation between forms of cash being held for spatial salability. Under the gold standard, the need for saving was met by the same money. But bitcoin offers a savings technology with superior salability across both time and space.

High Cash Reserves

The emergence of bitcoin as a hard asset, free from debt, supplies everyone in the world with a compelling alternative mechanism for saving. Unlike fiat money, whose supply is constantly expanding, bitcoin has a predetermined and constantly decreasing supply growth rate. Unlike stocks and bonds, bitcoin has no yield, which is more suitable for a monetary role. If stocks and bonds appreciate because of increased demand, their dividends and yields decline, making them less attractive to hold, and creating a bubble in their valuations. Either their valuations will decline nominally, or they will decline in real terms as devaluation continues.

By having no yield, bitcoin’s appreciation does not make it less attractive as it grows. Bitcoin in this way is like gold but superior because of its higher salability across space. This makes it less likely to be captured and centralized by political authorities or corporate powers. As bitcoin is also starting from a small market capitalization, similar capital inflows will cause a much higher rate of price appreciation in bitcoin than gold. This makes it a more attractive proposition as a store of value for the future, since it is likely to increase the value, not just preserve value.

Bitcoin’s higher spatial salability makes it possible to have a high degree of cash reserves on hand. This is because individuals can withdraw their assets far more easily than in banks and physical currencies. They can also perform international settlement with it at a tiny fraction of the cost of physical gold, and so are far less reliant on monopolistic banks and payment rail operators. The lower the salability of a currency across space, the more reliant individuals are on physical infrastructure and government oversight to conduct their trades. Thus, it is harder for them to sever a banking relationship should the bank engage in behaviors that put clients at risk. While bitcoin cannot offer everyone the chance to make on-chain transactions every day, it can offer many millions, and maybe billions, an affordable credible threat of withdrawing their balances and taking full possession of their coins in a matter of minutes. With bitcoin’s blocks acting as clear consensus checkpoints on ownership of coins, which are fully audited by all network members, there is a clear demarcation between present bitcoins and future bitcoins, allowing for an easily verifiable public test of liquidity and the ability to fulfill financial obligations.

Individuals might initially buy bitcoin for short-term price speculation, to conduct black market transactions, or as an experimental technology in payments. Some might be ruined by the volatility in the short term. Many will quit. But bitcoin’s relentless upward trend will make the value proposition of holding bitcoin as cash clear to most holders. People who allocate a small percentage of their net worth to bitcoin will likely watch it become a progressively larger fraction of their portfolio over time. Others will notice and copy them. Financial analysts will notice the spectacular rise over time and start recommending allocations into it. This process has intensified over the last few years, with a growing number of people worldwide now saving a fraction of their paychecks in bitcoin via dollar-cost averaging, and a growing number of services dedicated to this.

Corporations are also likely to recognize this value proposition and consider replacing parts of their cash balances in bitcoin rather than in national currencies. In mid-2020, we saw the first example of a company using bitcoin as a cash reserve asset, when MicroStrategy, a billion-dollar publicly traded firm, announced that it bought 21,454 bitcoin, worth $250 million at the time, to hold as a cash asset on its balance sheet. This makes it the first publicly traded company to hold bitcoin in its cash balance and the first company to hold bitcoin as cash despite having no operational or business reason for holding bitcoin.

MicroStrategy is not a bitcoin exchange or mining company whose business revolves around bitcoin and for whom holding bitcoin is necessary. This is a strategy and consulting firm whose work does not have any connection to bitcoin. MicroStrategy is not buying bitcoin to use it as a payment network. Nor is it wasting resources on the futile quest to use “blockchain technology” applications that do not involve bitcoin, as corporations like Microsoft and IBM have done over the past few years, with exactly zero return. MicroStrategy is buying bitcoin to hold it on its balance sheet because it has recognized it as a superior cash reserve asset to the U.S. dollar. In their announcement, MicroStrategy explains why they chose Bitcoin:

“This investment reflects our belief that Bitcoin, as the world’s most widely-adopted cryptocurrency, is a dependable store of value and an attractive investment asset with more long-term appreciation potential than holding cash. Since its inception over a decade ago, Bitcoin has emerged as a significant addition to the global financial system, with characteristics that are useful to both individuals and institutions. MicroStrategy has recognized Bitcoin as a legitimate investment asset that can be superior to cash and accordingly has made Bitcoin the principal holding in its treasury reserve strategy.

We find the global acceptance, brand recognition, ecosystem vitality, network dominance, architectural resilience, technical utility, and community ethos of Bitcoin to be persuasive evidence of its superiority as an asset class for those seeking a long-term store of value. Bitcoin is digital gold—harder, stronger, faster, and smarter than any money that has preceded it. We expect its value to accrete with advances in technology, expanding adoption, and the network effect that has fueled the rise of so many category killers in the modern era.

We have a large amount of USD on our balance sheet and we have carried that for a while. Over time, the yield on our dollar values has decreased and at points, we had an expectation that we would get higher real yields, and therefore, there was no real urgency to address this issue. But as of today, we’re expecting negative real returns or a negative real yields on U.S. dollars, and that’s an expectation that has materially changed over the course of the last three months.”

Demonetizing The World

The nonmonetary alternatives fiat man must use as cash cannot perform the role of money much more satisfactorily than a spoon can perform the role of a knife. Bonds and stocks can no longer offer yields that beat money supply inflation, and both carry heavy risks. Real estate is highly illiquid, indivisible, and requires high maintenance costs. Gold and silver have low spatial salability, as there are no precious-metal-based banks allowed in the fiat era. They also entail heavy transaction fees with each purchase and sale. Managing a savings portfolio is an endless task of weighing a multitude of risks against potential returns for an endless variety of markets.

The absence of a workable medium of saving also results in the distortion of markets for all other alternative monetary goods. Excess demand for bonds rewards undeserving borrowers, most notably governments, misallocating capital and causing periodic default crises. Excess demand for real estate leads to the rise of real estate valuations. This prices out younger generations and causes periodic housing market crashes. The increased demand for anything that offers scarcity causes a rise in valuation for art, resulting in the incredible inflation of valuation for products hardly differentiable from children’s scribbles. Commodity and equity markets are heavily distorted by the excess demand looking to avoid inflation. Across the board, the quest to protect value from inflation has disconnected prices from reality.

If bitcoin’s liquidity grows significantly, it would offer an increasingly compelling and efficient alternative to these technologies. Demand for these assets would become purely industrial and commercial rather than monetary. Housing would return to being thought of as a consumer good rather than a savings account or capital good. House prices would reflect demand for houses only as places to live, not as savings accounts. Commodities’ prices would reflect demand for the commodity itself. Equity would reflect the underlying fundamental values of the company rather than being a gauge for monetary policy as it is now. Artists might need to return to learning skills and putting effort into their work to sell it and not just rely on people’s search for anything scarce to buy their products.

Unbounding the World

The monetization of bitcoin competes directly with the monetization of fiat debt, a hugely significant fact with far-reaching implications for traditional bond markets. The continued growth of bitcoin would likely result in a reduction of demand for debt instruments as a method of saving. As national currencies are expected to devalue significantly, they constitute a small part of what investors think of as their cash balances. These assets include gold, bonds, and debt instruments that are free from equity risk. As more individuals and corporations like MicroStrategy buy more bitcoin to hold as their high liquidity low-risk asset, they will demand fewer bonds and debt obligations.

Should this trend continue to grow until it reaches an appreciable volume of global financial assets, bitcoin will have a profoundly transformative effect on the shape of the world’s capital markets, banking sector, and government spending. The enormous incentive to borrow in the fiat standard, discussed extensively in Part 1 of this book, is ultimately driven by the monetization of debt, which creates a huge incentive for lenders to create more loans, and also driven by savers’ need to hold debt instruments with yield to compensate for inflation’s erosion of purchasing power. But demand for holding these loans would decrease when investors choose instead to hold bitcoin, and so the demand for lending would decline too.

Chapters 3 and 11 outlined in some detail how the operation of the fiat standard revolves around the central bank monopoly for banking licenses and foreign transactions. This places all bank accounts and financial assets under the custody of the central bank, allowing it to lend to the government with the citizens’ wealth as collateral. Whether through explicit default or subtle inflation, the value of the assets will decline as the bonds are issued and the money supply grows. The devaluation of the currency itself is what creates the demand for the bonds, which in turn allows for the devaluation of the currency, in the eternal perverse cycle of fiat monetary damnation of the last century. This cycle is what allowed government debt to grow to the extent it has over the past century, far beyond what governments’ creditworthiness would merit. Almost $100 trillion of bonds have been issued by government entities at the time of writing, making this arguably the largest malinvestment in human history. By turning government credit into money, the fiat standard has acted as a continuous drain of resources from productive members of society to governments that spend with very little accountability.

What happens if savers increasingly prefer to hold hard money over government debt? The impact may not necessarily be sudden, leading to a collapse of bond markets, but if combined with continued devaluation of national currencies, it could lead to the gradual decline in the economic value of the bond market in real terms even as nominal fiat numbers continue their unending rise.

Bitcoin offers superior salability across space and time to bonds, gold, and government cash. But its main drawback is still its relatively small liquidity. At the current market price of around $40,000, the total market value of all bitcoin in circulation is around $800 billion. This is a sizable number that positions bitcoin among the largest national currencies, but still a drop in the bucket of the total market value of bonds, which is around $140 trillion. Bond markets still offer significant depth and liquidity for the largest institutional investors. But bitcoin, as it grows, has the advantage of being a monetarily fungible good, so demand for bitcoin can be met by any bitcoin seller. In the bond market, on the other hand, while overall market liquidity is quite large, the liquidity available for individual bonds and maturities are fractions of the overall liquidity. The homogeneity of bitcoin and its lack of a yield give it a natural advantage over bonds in playing the role of money. Gold was chosen as a money on the market precisely because it has no yield. The role of money optimizes liquidity at the expense of risk and return, while equity optimizes for return at the expense of liquidity. In a world where there is little incentive to monetize debt, it is doubtful that any demand would exist for bonds.

Robustness

A financial system built on a hard monetary asset at its base would be far more robust than one built on debt obligations at its base, and would cause far fewer financial and liquidity crises. The monetization of debt, through the treatment of future promises of payment as being monetary assets similar to cash on hand, creates an inherent fragility to the fiat monetary system. During times when financing conditions are favorable, banks are able to meet their financial obligations, as are most of their customers. But market financing conditions can turn unfavorable, for many reasons: monetary policy tightening, collapse of large borrowers or financial institutions, natural disasters, and wars are just some examples. When funding conditions become unfavorable most, or all, debt obligations are valued at a discount by the market, which places financial institutions using them as their financial assets to have a precarious position. This creates liquidity crises which plagued the fiat standard in the twentieth century, and which mainstream economists have come to agree can only be treated through the injection of liquidity into the monetary system.

A financial system built on full cash reserves would not experience such liquidity crises, as financial institutions would keep on hand cash instruments equal to the face value of all their liabilities that are redeemable on demand. Whatever the state of the credit market, the bank would have on hand enough cash to satisfy all depositors and creditors to the full extent of their claim, as the claims are themselves denominated in that cash, and the quantities of cash are held on hand. The growing monetization of bitcoin allows more people to peacefully opt out of having to hold debt as their prime treasury reserve asset and allows them a hard cash asset whose value is not contingent on future cash flows and credit risks.

Full Reserve Banking

The processing of payments can be understood as a market good that becomes more valuable as the scale of an economy grows and the circle in which a person trades expands. The increasing value stems from the clear economies of scale banks have in clearing, netting, and settling large numbers of transactions as opposed to individuals carrying these out individually. Some examples are paper notes backed by gold, bills of exchange, modern credit cards, and PayPal accounts.

In any monetary system, such networks for banking and settlement will emerge, and they will benefit from economies of scale by holding many accounts for people and netting transactions, bypassing the need to physically transfer money (or in the case of bitcoin, the need to transfer assets on-chain). Under the gold standard, the physical movement of gold was expensive and insecure, and economies of scale accrued to those that physically amassed reserves and thus could provide a centralized clearing mechanism. As a result, only a few global central banks could cost-effectively trade gold internationally. The emergence of fractional reserve banking on top of this system can then be understood because of the banks’ ability to expand credit. They are backed by their operational capital and aided by a trusted network of banks with which they can clear.

In a sense, fractional reserve banking could be sustainable when the alternative to dealing with banks is too expensive, and banks’ reserves are high enough to make crisis-level mass withdrawals unlikely. If the physical settlement is expensive and the network of banks is indispensable for its customers, banks could conceivably get away with not keeping all deposits on hand without experiencing a bank run. It is possible for fractional reserve banking to continue in a bank that is the only one in a town, or where it enjoys some monopolistic privilege from the government because there are no easy alternatives for clients to process payments if they choose to withdraw their money from the bank. This becomes particularly easy if the money is easy for authorities to use to prop up insolvent banks.

The degree to which a bank can get away with fractional reserve banking is a positive function of the cost of the final settlement of the monetary asset and the ease of debasing the monetary asset. Under a gold standard, the cost and time required to move gold around are relatively high, so the economies of scale from centralization will provide existing banks a degree of leeway in extending unbacked credit without their depositors noticing or being able to do anything about it. Yet this system is not very sustainable, because the longer it lasts, the safer banks feel, the more risks they take, until it comes crashing down, as was the case during the nineteenth century. Since it is not easy to increase the supply of gold on demand, and no lender of last resort can print it to bail out banks engaged in fractionally lending gold-backed notes, fractional reserve banking was the bug that kept on derailing the gold standard. Eventually, the gold standard itself was sacrificed to keep fractional reserve banking alive when a dollar-based standard was used for settlement. This makes settlement entirely centralized with a government monopoly while leaving the currency elastic to the demands of the banking sector.

Here we see an advantage that bitcoin has over gold: it can provably perform hundreds of thousands of settlements a day. Compared to the physical movement of gold, the final settlement costs are much lower, which translates to fewer economies of scale for centralized bitcoin clearing, and thus even less incentive for a central banking ecosystem around bitcoin to emerge. Any system for bitcoin settlement would be far more distributed at its core than gold. The benefits from economies of scale are not as pronounced as with the case of gold. There is room for far more institutions to be able to perform settlements with one another. With higher spatial salability comes higher capacity for more transactions and less unbacked liabilities.

Equity Finance

Bitcoin-based financing will likely cause a shift toward more equity investment rather than credit instruments and interest-based lending. We can identify three drivers of this trend. First, if bitcoin continues to rise, the seigniorage benefit from monetizing debt will dissipate, as people monetize a hard asset instead. This on its own would reduce the incentive to issue debt.

Secondly, the the lack of a lender of last resort further reduces the incentive for interest-issuing debt. With a strictly fixed and perfectly auditable supply which anyone can verify with relatively affordable hardware, there is very little scope for any entity such as a central bank to pass off its own liabilities as money, and increase the money supply. Fiat allows banks and central banks to pass off their own liabilities as money, because they ultimately have monopoly control over the infrastructure that gives the money its spatial salability. Under the gold standard, too, gold’s limited spatial salability, and the difficulty and cost of physical redemption also gave banks, particularly larger ones, the ability to pass off their obligations as money, and to act as lenders of last resort. Without a lender of last resort, it becomes very difficult for a bank to offer a fixed-interest loan with a guaranteed return, as there can never be a guarantee that the bank won’t face insolvency. Risk of complete ruin is ever-present in any business enterprise, and any bank that backs its demand deposits with loans issued to businesses is taking on the risk of the business’s complete ruin. There can never be a mechanism for guaranteeing the return of capital if it is to be involved in a business activity. Even with insurance, there are acts of war and nature that cannot be insured against, or where the insurance companies go bankrupt themselves. Banks simply cannot make a promise to return capital to the depositor with an interest. They are undertaking risky investment and the depositors is always taking on the risk of being wiped out without a lender of last resort able to compensate them for their loss by distributing it over existing currency holders through inflation.

With bitcoin’s high spatial salability and quick final settlement capabilities, the possibilities for a bank to offer fixed interest returns for on-demand deposits is even more difficult to foresee. With bitcoin able to perform so many global transactions, there is likely to be less advantage to access to the payment rails of any particular bank than there is to access to fiat monopoly payment rails. Depositors who suspect their deposits are being lent out can very quickly withdraw and leave the bank insolvent. It is doubtful that the extra returns banks are able to generate from lending demand deposits, as they do in a fractional reserve banking system, are even possible in a hard money economy where no lender of last resort exists to protect the banks and their clients from the downside risk. With the clarity brought about by the fixed supply, and the efficiency brought about by the high spatial salability, it is likely for banking to bifurcate into its two essential and clearly demarcated functions: deposit banking and investment equity banking. One could argue the gray area of investing in credit and fixed-interest rate lending is a function of the limitations of spatial salability and supply vagueness of fiat money.

With a highly salable money like bitcoin, depositors who want access to their money will only be able to get it safely by placing it as a deposit and paying a fee for its safe-keeping. Investors who would like to earn a positive nominal return on their bitcoins would need to accept the risk of default and complete ruin inherent to a money with no lender of last resort. With the downside unlimited, there is little reason to agree to an investment with a fixed upside, as is the case with fixed interest loans. Seeing as the money is all at risk, investors who accept fixed interest loans on the long-term will lose capital, as their upside is limited and their downside is unlimited, and with enough investments, the losses will accumulate. They will likely be outperformed by investors who take an equity stake, and thus match their unbounded downside with unbounded upside, collecting better returns.

The third driver of equity finance is the growing accumulation of cash balances. As cash’s zero nominal returns translate to positive real returns with a hard money, cash becomes a more attractive financial instrument than debt on individual and corporate balance sheets, leading to a growing abundance of it. The availability of cash reduces the incentive to lend, and the resulting abundance in cash reduces the return on lending. As human civilization progresses, and money improves as a technology, humans accumulate more cash balances and that leads to lower interest rates on the price of capital.

The process of human civilization, as the lowering of time preference, is driven by, and in turn drives, more savings and lower interest rates. Austrian economist Eugen Bohm-Bawerk said that cultural level of a nation is mirrored by its rate of interest, as explained by Schumpeter:

[Interest] is, so to speak, the brake, or governor, which prevents individuals from exceeding the economically admissible lengthening of the period of production, and enforces provision for present wants—which, in effect, brings their pressure to the attention of entrepreneurs. And this is why it reflects the relative intensity with which in every economy future and present interests make themselves felt and thus also a people’s intelligence and moral strength—the higher these are, the lower will be the rate of interest. This is why the rate of interest mirrors the cultural level of a nation; for the higher this level, the larger will be the available stock of consumers’ goods, the longer will be the period of production, the smaller will be, according to the law of roundaboutness, the surplus return which further extension of the period of production would yield, and thus the lower will be the rate of interest. And here we have Böhm-Bawerk’s law of the decreasing rate of interest, his solution to this ancient problem which had tried the best minds of our science and found them wanting.

This lowering of interest rates is a process that has been taking place throughout human history, as discussed in detail in Homer and Sylla’s The History of Interest Rates, which documents 5,000 years of data on interest rate history, in which interest rates are in a long-term declining trend, interrupted by various catastrophes. By the end of the nineteenth century, after decades of the international gold standard and the ensuing capital accumulation, the lowest interest rates were around 2%. The move to fiat, and the ensuing world wars reversed this trend in the twentieth century, but there is no reason to assume it would not continue with a return to hard money. And as it continues, it is hard to escape the conclusion that it would head to zero. Lending would be done at a nominal rate of return of zero, but a positive real return, which is the result of both the appreciation of the monetary asset, as well as the lender saving on their storage cost and risk of loss or theft. Carrying a cash balance always involves a cost and risk, and by lending, the lender is able to offload that cost and risk to the borrower, so that even receiving a zero percent interest would be a positive improvement.

I suspect that the end result of developing hard-to-confiscate strictly scarce hard money with very high capacity for decentralized fast global settlement is that interest rates would naturally go to zero, to the point that interest-based lending would seize to exist. Given that money would be expected to constantly appreciate, a zero percent rate of interest is a positive interest rate in real terms. And given that the holding of deposits would usually incur a cost, there is an opportunity cost to holding on to money rather than lending it, which effectively increases the real rate of return of a 0% nominal loan. Combined with increased savings and lower time preference, all this is likely to lead to there being an approximately zero percent nominal rate on credit. Creditworthiness will be all that matters in these loans, and not an interest rate. But such lending is more likely to take place between family, friends, and people with some kind of relationship between them, or the likelihood of repeated interaction. For business lending, it is hard to see lenders willing to forego capital and take on venture risk merely to save on storage cost. Rather than seek a fixed yield for lending, lenders would seek an equity stake and a share of the business’ revenues.

Every business, including banks, can go to zero. In a fractional reserve banking system, central banks protect depositors against such an outcome by generating new easy money. In a hard money system, there is no amount of financial risk engineering that can protect savers from the loss of their capital in a venture. Banks can diversify but can never make a guarantee for a minimum return or maximum loss. Without the ability to protect the downside of the saver, there is no reason the saver should not prefer to be fully exposed on the upside as well. Why settle for a fixed return on their investment if it succeeds but unlimited downside if it fails? The more attractive model for savers will be one in which they make a real return from the businesses in which the bank invests their money, sharing in the profit and loss. The role of the bank will be in matching maturities and risk profiles between borrowers and lenders and identifying the correct projects in which to invest.