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What does Quantum Banking have to do with Bitcoin?

Quantum banking is the phenomenon where bankers allocate money in more than one place at the same time. The other term for this is fractional reserve banking. This article is inspired by a twitter post by Dan Held, a bitcoin influencer, and leader of growth at Kraken.com. In the past 100 years, we’ve come to understand more about the quantum world. One such phenomenon has since made its way into popular culture. It’s the idea of superposition, although most of us know it as the story of Schrödinger’s Cat. Although this is a bitcoin article, on a cryptocurrency news site, Schrödinger’s Cat may have more to do with monetary policy than you think.

Empty Bank Vault

The vault bar at The Ned hotel on the 4th October 2019 in London in the United Kingdom. The Ned is a luxury hotel and private members club in the City of London. The location is set in a former bank head quarters designed in 1924 by Sir Edwyn Lutyens. (photo by Sam Mellish / In Pictures via Getty Images)

What is Quantum Banking?

In order to understand quantum banking, it is useful to be familiar with the basic premise of Schrödinger’s Cat. The idea goes like this. There is a cat in a box, and in the box there is poison. You are on the outside box, and you have no idea whether or not the poison has been released on the inside of the box. You are unable to determine whether or not the cat is alive or dead. Therefore, the conclusion is that the cat is both alive and dead at the same time. It can be said that the cat is in more than one state at once. What does this have to do with Quantum Banking?

Fractional Reserve Banking

As it turns out, bankers really like the idea of money being in more than one place at once. In fact, fractional reserve banking has been around for centuries. Early on in the history of banks, the managers noticed that it is very unlikely that all of the bank’s customers will want their money at once. They realized that rather than have money just sitting around in vaults, they can loan it out to other people. In principle, this is a totally sound idea. People almost never use the full balance of what they have in the bank. It is then good practice for banks to make use of the money. Giving this money out in loan format is one of the cornerstones of our economy. Fractional reserve banking is one of the things that allows us to be as productive as we are as a society. In essence, fractional reserve banking is the allocation of the same dollar, in more than one place.

If I have $1000 sitting in my bank account. I may be earning 1% interest on that dollar. At the end of the year, I will have $1010. Happening at the same time, the bank has loaned the same $1000 to a vendor down the street, at 2% interest. At the end of the year, the bank made $20 on the $1000, and gave me $10 of it. The vendor is happy because they got access to money to run their business. I am happy because money that I wasn’t using made me more money, even if it is a small amount. Quantum banking is a very tongue and cheek (and modern) way of referring to fractional reserve banking.

The Problem with Fractional Reserve Banking

Fractional reserve banking is not without its problems. Earlier in the article, I stated that bankers noticed it was unlikely that their customers would all request funds at the same time. Unlikely, but not impossible. Several times throughout history, many people at once have requested their money from their bank. When this happens, it’s called a bank run. The number of people that need to request their money at the same time is related to the reserve requirement. That is, the amount of money that the bank is required to hold. If a bank is holding $1000 for someone, a 10% reserve requirement means that they need to hold $100, and can lend out the remaining $900.

One of the jobs of the federal reserve is to set the reserve requirement. The reserve requirement has been falling precipitously over the course of the last decades. In March of 2020, the federal reserve requirement was set to 0%. Yes, this means that the bank can loan out all $1000 of your dollars, to as many people as they want, as many times as they want. This firmly puts us into the territory of abusing something useful.

It’s Time to Look In the Box

The last part of Schrödinger’s Cat is when you look in the box. It is not until you look into the box that you can know the true state of the cat. With this thought experiment, it is assumed that there is a 50/50 chance the cat is dead or alive, and therefore both at the same time. Let’s apply the same thought experiment to money in a vault, where the reserve requirement is 0.

We know that the bank can loan out 100% of the money in the vault if they want to. So why wouldn’t they? If they can make more money, by making more loans, history will show us they will. When we open a vault to find out whether or not the money is there or not, we can be almost certain that it won’t be. The fractional reserve banking system, which is now a zero-reserve banking system is a bit like playing with fire. What is bitcoin’s monetary policy with respect to fractional reserves?

Bitcoin and Fractional Reserves

Just last week, the OCC announced that all American banks may now be custodians of cryptocurrency. This means that I can deposit bitcoin into a bank account. This presents a problem of gargantuan proportions. What if the banks lend out bitcoin?

There is a finite supply of bitcoin. It’s 21 million. There will never be more than 21 million bitcoin. The problem presents itself when any bank decides that they want to lend out bitcoin an infinite number of times. Bitcoin is not like the dollar. We cannot just print more, or get a bailout in the event that there is an economic crisis or bank run. If a bank were to lend out bitcoin an infinite number of times, it could end up being a mistake that they cannot recover from. The monetary policy of bitcoin is to deal in the absolute value of the asset, never in fractional reserves. It is imperative that banks understand this, and do not try to lend out the bitcoin that their clients have deposited. Although, I do think that this is a situation that we as a society, will inevitably run into.