How does the banking system work? – Why BITCOIN could change the world?
BITCOIN, besides being the first cryptocurrency, is the best known and most popular of the more than 5 000 that exist today. It is also famous for its volatility or dramatic rise and falls in price since its launch in 2009. The price of bitcoin in the first few years did not exceed 100 and in November 2021 it reached an all-time high of 67 000. More and more people, companies, and institutions are interested in buying.
The question is whether its popularity is due only to its previous high valuations or whether there are reasons to consider bitcoin as good as gold for thousands of years societies around the world began to choose precious metals such as gold and silver as money because they fulfill certain unique characteristics, for example, gold is divisible. It can be converted into smaller pieces. It is durable because it does not decompose or deteriorate over the years.
It is recognizable, meaning that its authenticity can be verified. It is portable meaning that it can be moved from one place to another, and it is scarce because it requires a lot of work to extract and refine so the supply of gold only increases by about two percent each year, which means that its supply is predictable. Otherwise, if producing gold was easy, it would not serve as money or a store of value.
So gold is almost perfect, has been good money for over 5000 years, and has served many purposes. The problem with gold is its difficult portability in large quantities. Hence the business of vaults arose to guard those large quantities of gold, and these later became banks.
So the gold was deposited in a vault and a paper receipt or certificate was given to the bank stating the value of the gold stored in the vault. That paper, then, was as good as the gold, because with it anyone could go to the bank to claim the gold.
Therefore, with this paper, it became easier to make transactions because it meant that the person did not have to carry gold but paper. That could be redeemable at any time. This framework was known as the best quality level.
That is a system in which banks had to have physical gold reserves so that anyone could go to the bank with a bill and exchange it for gold. Even until a few decades ago there was a similar system called the gold dollar standard.
It turns out that when world war ii was ending, Europe was destroyed and the united states benefited on several fronts. One of them was to become a kind of world bank because it had the largest gold reserves in the world. Therefore, in 1944, representatives of 44 allied countries met in Breton woods, a small town in the state of New Hampshire.
There a plan was drawn up to stabilize the world financial system after the war. To achieve this, us dollar was chosen as the world’s reserve currency and gold as its backing. In other words, it was not the traditional gold standard, but a kind of dollar gold standard in which all countries fixed their currencies about the dollar and the united states undertook to fix the dollar about gold.
In theory, every 35 dollars should be backed by one ounce of gold. However, the Bretton wood system would only last 25 years. The united states at that time were incurring heavy expenses to finance the Vietnam war and went to printing much more money than it could back with gold, which led to Richard Nixon.
The president of the united states called an emergency press conference in 1971, announcing that the united states were disengaging from the Bretton woods agreements I.e. The dollar gold standard, which meant that countries could no longer convert their holdings of u.s dollars into gold. With this surprising announcement, a new era began a system in which no currency is backed by gold.
Therefore, countries had the possibility of printing banknotes without the need of having any banking, and this is the system that is still in force today.
In the past, credibility was given by gold reserves. Now it is based on the confidence that those who have the power to create money do it responsibly. Otherwise, if money is created in excess, if more bills are printed, the purchasing power granted by those bills decreases.
In other words, inflation is generated, and less and less can be bought with the same dollars. If there is more money circulating in pursuit of the same amount of goods, prices will tend to rise we are born into a system where most believe that inflation is inevitable, that it is a natural process for almost everything to be worth more year after year.
Yet, under a system close to capitalism, prices should be lower and lower thanks to increased productivity and more efficient processes. On the contrary, we are seeing inflation in many parts of the world reaching historically high levels, coinciding with the fact that in recent years, central banks have pumped trillions of dollars into the economy, although some believe that wealth can be increased by printing banknotes.
The truth is that this has consequences. One of them is that it leads to what is known as the Cantelon effect, for example, when the federal reserve, which is the central bank of the united states, prints money or better yet adds zeros in a computer, that new money is not distributed equally throughout the economy, usually, the first to receive the new money newly created out of thin air is the government which uses it mostly to finance its operation.
Debt repayment and interest on debt and being the first to receive the newly created money is an advantage because it has not yet had an impact on inflation. Those who are hurt by this expansion of money are those who have fixed incomes, retirees, or those who do not have assets that are valued with the inflation generated by the greater amount of money now in circulation. On the other hand, central banks are not the only ones that can create money.
Commercial banks do so as well. Commercial banks are required by law to hold a minimum amount of money in their reserves. According to the cash reserve ratio determined by the central bank, for example, if the cash reserve ratio is 10 percent commercial banks must keep ten percent of the total money collected as reserves. So if a client deposits one hundred dollars in a bank, the bank only has to keep ten dollars. The rest can be used, for example, to grant a ninety-dollar loan to another client, and if
this client deposits ninety dollars in another bank, and the same thing happens in the end with this ratio, banks could multiply that initial one hundred dollars into one thousand dollars, and this is how commercial banks also create money there are ways to moderate this, but this is a potential scam by the current financial system, because what would happen if all customers wanted to withdraw their money from the bank on the same day? Well, the system would collapse because the banks would not have all the money requested.
They know this in Argentina with what was called the corralito when cash withdrawals by Argentines were restricted. For those reasons, this is a system that is based on trust, on the promise that banks will deliver the money that was initially deposited, and this is where bitcoin comes from a decentralized digital currency that can be bought, sold, or exchanged without the need for an intermediary.
Such a bank and other currencies such as the dollar or the euro are also digital, but these are fiat currencies, that is to say, they can still be created out of thin air. In contrast, the supply of bitcoin is limited to 21 million coins with the current banking system.
when you deposit money in a savings account you’re, actually lending money to the bank, and as we saw the bank can create more money with that money. You trust that in the future, it will pay you back, but there is no absolute certainty, on the contrary, if you have bitcoin, it is no one else’s responsibility.
You do not have to trust a third party to pay you back in the future. That is why bitcoin is said to be as good as gold. It is also divisible because, even though one bitcoin is worth more than forty thousand dollars, you can buy much smaller fractions of bitcoin. It is durable because it is digital and will not wear out over time. It is recognizable that is, its authenticity can be verified.
It is portable because bitcoin can be sent to another person anywhere in the world as if it were an email, and it is scarce because only 21 million bitcoins will be created according to the initial protocol. This means that no more bitcoins can be created out of thin air, as is possible with other fiat currencies. Even so, one could not be sure that bitcoin will be like gold or that it will replace it.
but at least they do have similar characteristics from there. What might happen in the future is uncertain. The idea that bitcoin could replace gold, which has been used for more than 5 000 years, is very disruptive, plus it can be frustrating for most of us trying to understand how the bitcoin blockchain and the complex world of cryptocurrencies work anyway.
For now, bitcoin is seen by the general public as a speculative asset, most by bitcoin because of the high vvaluationthe headlines, and the form, which means fear of missing out. That is the fear of losing the opportunity to make money. However, most of these buyers end up understanding the reasons why bitcoin could change the functioning of the global financial system.