Reserve Rates:
What are they? Why do they matter? What do they have to do with crypto?
Understanding traditional finance is very important if we want to solve its problems. It is not enough to say it is broken, we need to know why.
Original data and calculations: https://docs.google.com/spreadsheets/d/1wTfC40ynvC4t_1jY6M0A4AI6IG_ISObkwTgE_PQk9Qk/edit
At Clip Finance we have done a bit of research to bring you a case study. This will blow your mind and strengthen your belief in blockchain 1000x
What are reserve rates? Reserve rates are stipulated by the FED and regulate how much of a deposit a bank needs to keep on hand. For instance, if the reserve rate is 10%, that means that the bank needs to hold $10 of every $100 you deposit there. But where does this other money go? We will get to that in a second.
This news may counter some people’s understanding of bank’s structure, because this sounds like they are investing your money, yet you see little to no return on your deposits, right? Yet this is the way it is and it will become clear soon why that is.
The other $90 will be lended out by the bank to a person or business that qualifies for a loan. This could be to buy a car or a house, anything really. Sounds fine right? This is where it gets bad though.
That $90 when received by the loan applicant is usually put into a bank account. This new bank then has a $90 deposit, of which they only need to keep 10%. They loan out $81 to another person or business and the cycle continues.
$100 (first deposit) > $90 (second) > $72.9 (third) > $65.61 (fourth)
A trail of new loans and new deposits, each leaving 10% of the capital with the bank the deposit is made with. You can see even after 4 cycles we have $328.51 in payable deposits and only $100 was deposited. Keep in mind that every time a new loan is given by a new depository institution, that bank still “owes” the depositor the entire balance deposited.
If it wasn’t clear, this is the structure of banks that makes the situation in which there is a “run on the bank” possible. These economic mechanics of the banking system lead to very unbalanced debt to deposits ratio that builds itself to more and more precarious heights over time. These mechanics are also the reason the US dollar is colloquially referred to as a “debt backed currency.”
Some might argue that these cash creation events lead to more economic growth because banks are able to loan more to businesses which leads to more products to be generated. I would argue that it is wholly unsustainable.
But wait, it gets worse. Way worse. A long while back, around 1842, when use of bank notes (a note backed by specie: gold or silver) were common, states such as Lousiana passed laws that required banks to keep 1/3 of the public value of their bank notes in reserve. Other states ranged between 10%-33% reserve rates. Later on banks were required, by the National Banking Act of 1860 to only hold between 15%-25%, which was further reduced to 10% when the FED was created.
And guess what: due to “economic pressure” during 2020, the FED reduced the reserve rate to 0%. This means that every single dollar that is deposited can be loaned, and so on and so forth forever. An infinite money glitch if you will.
Imagine $10,000 gets lended and deposited 50 times, there are now $500,000 of deposits that can be called on at any time and the only source of revenue for the bank is the interest rate they charge or other streams of revenue that no doubt have other liabilities attached.. So at best given the current rates they could make $50,000/annum, and yet they still have $500,000 in liabilities.
This graph shows the decay of $10,000 over 50 period. The higher the reserve rate, the faster the decay leading to less liabilities as less money is loaned.
This graph shows the total amount of money generated by 50 lending periods. Keep in mind that there is no limit to how many times the money can be lended and deposited, so the higher the reserve rate the faster the lended amount reaches $0 and money stops being generated.
Banks are not keeping your money safe. They are destroying its value, while charging you fees.
The nature and history of the FED does not provide any guarantees about the future of the dollar, other than continuing on the same path we are on. And this is not just an American problem, the Central Bank of Europe stipulates that banks hold only 1% of deposits.
We hope you got some value out of this article, at least more than USD is worth. Remember, there is an ever increasing volume of USD out there. There are only 21mm BTC. And there will only ever be 10mm $CLIP. Being your own bank and earning nearly double digit APYs might be something you should consider. If it is, check out clip.finance/earn where we are doing something to solve this problem. Think long and hard about this and of course: DYOR.
