Stephan Livera | SLP402 Pierre Rochard — Bitcoin Obsoletes Fractional Reserve Banking

Link to the YouTube (the timestamps are based on this): https://youtu.be/NwIEP4xmGYI

Stephan Livera: Pierre, welcome back to the show.

Pierre Rochard: Stephan, thanks for having me back on.

Stephan Livera: So I wanted to chat about Bitcoin full reserve as contrasted with fractional reserve and all of this. But actually first of all, congratulations on the new role as the VP of Research, is it, over at Riot Blockchain, right?

Pierre Rochard: Yep, that’s right, thank you. And any views expressed on this podcast are mine. Not investment advice, DYOR — all the disclaimers.

Stephan Livera: Yeah and we’ll get into all kinds of stuff around Bitcoin full reserve, fractional reserve. I think it can be quite controversial. In some people’s views, that’s seen as very over-the-top or hyperbolic as some people might think of it, but I think there is just a genuine — people should have their own thought on it. And so let’s start with a little bit around some of this debate: if you could maybe give a little bit of an overview for people, like what is this whole thing about fractional reserve, full reserve? For people who are not really clear — people have just been using their normal banking accounts. Like, what’s the situation today?

Pierre Rochard [1:24]: Yeah, absolutely. So first off I’d start — I mean, as you mentioned, there’s quite a bit of energy in this debate! And I’d emphasize that if anyone disagrees with what I have to say today, I’m always open to counter-arguments: I’m really interested in always learning more and refining my point of view, because I don’t think that the issue of full reserve versus fractional reserve is central to my views on Bitcoin at a macro scale or even on a micro. And same thing with like S2F, right? People are like, Oh S2F is like a central part of the investment thesis for Bitcoin, or it’s not, etc. I think that, at the end of the day, Bitcoin is Bitcoin, right? We always say that. And so I’m happy to be wrong on anything that is peripheral to Bitcoin, just like eating steaks or anything like that — it’s not a big deal if we’re wrong! As long as we’re right about Bitcoin. Okay, so with that caveat — yeah, feel free to put me on blast on Twitter if I say something stupid and you have hard facts and sound logic to dismantle it. So in terms of where we are today for fractional reserve, arguably we’re no longer in a fractional reserve banking system. That is: that central banks around the world have set reserve requirements to zero percent so there’s no fractional — it’s just zero reserve banking. But the other part of it, too, is that when you have a government-sponsored deposit insurance like FDIC, arguably that itself is a form of full reserve banking, because now, because the government can print as much money as it needs to in order to make depositors whole, there’s not really any economic difference between that state of affairs and actually having already printed the money and putting it back in every single checking account. So I would actually argue: fractional reserve banking doesn’t exist anymore in the fiat system because it failed and it always fails. So if we rewind, we can look at when it did exist, and I think that it existed as an unstable equilibrium, right? So basically the idea with fractional reserve banking is that: rather than using specie — which is physical gold and silver, whether it’s minted by a mint or whether it’s actual grains of gold or silver, or any other currency — I mean, you could really talk about seashells as long as it’s physical seashells, not paper seashells: the principle applies! So people found it inconvenient and insecure to hold physical, and so they deposited their physical asset at a warehouse or some kind of depository institution, and it would be really convenient because, back in medieval times, rather than carrying your gold from Italy across the Alps to France, you could deposit your gold at a bank in Italy and then travel through to France with some kind of paper receipt and then withdraw your gold in France. It saves you the risk of being burglarized by highway robbers, or just the inconvenience of having to carry gold across a mountain. And same thing with boats, etc. And so you saw the development of banking systems like that. And then the fractional reserve part comes where now the depository institution or the warehouse starts issuing receipts not when somebody deposits gold, but rather when somebody wants to borrow from that institution, and so the depository institution will create the receipt. So in the literature, you’ll hear that this practice of creating ledger entries in order to lend out money substitutes will be called fiduciary media. And then the idea is that: because now this financial institution is really engaged in financial intermediation, that the warehouse receipts are not warehouse receipts anymore, but rather they are claims on the financial institution in the same way that they’re basically unsecured creditors, right? That then the value of those claims is freely floating in the market. And so what we saw in fractional reserve banking systems is that the fiduciary media would be freely floating against each other. So some banks would issue a dollar that is really worth 98 cents, and another bank that’s in a worse financial position — its dollar would be worth 84 cents, right? And then these money substitutes would be freely trading against each other and merchants would have to keep track of what the current exchange rate was between every bank’s dollar — or every bank’s liability that they had issued. Obviously this creates a situation of like barter, right? Where you’ve got all this additional friction, but also, it’s very hard for participants to be performing due diligence and credit analysis when somebody’s trying to buy a beer at a tavern, right? It’s like, Okay, let me look up where this money substitute is trading at. It’s not scalable — it goes back into the issue of inconvenience for everyone, and it also is just not a very stable system in the sense that you would get bank runs, right? And so a bank run is where people — whether it’s rationally because the bank is insolvent, or irrationally because they are panicking because some other bank is insolvent, not the one that they’re withdrawing from but some other one, and so there’s fear of contagion — that everyone’s trying to withdraw their money at the same time, and because the bank has only a small percentage of the assets as the actual specie that is trying to be withdrawn, and the rest of the balance sheet assets are actually loans that are loaned out that will have a maturity of maybe 1–3 years, that these are illiquid investments, that it would take a while for them to be able to sell those assets for specie and to redeem the claims on the bank, so you get a bank run. And that creates social instability, right? Now you have people who are unhappy because they can’t access their money and perhaps they will turn to violence or other things, and that’s where governments — now, I forget what it was referred to in with regards to prohibition, but you have the Baptists and the bootleggers. So the Baptists are the ones that want to do good and they say, Okay, well we need to have government intervention because depositors are being scammed, essentially. And then you have the bootleggers — who are the bankers — who are trying to make money and who say, We need bailouts! We need a lender of last resort! We need regulation! — which often is a way of having a moat around their business, right? A regulatory moat so that they can keep out competitors and establish themselves, because they are able to pay for the compliance costs and all this, and they have the relationships with the regulators and the revolving door, etc. So both Baptists and bootleggers pushed for additional regulation of banking. And with the establishment of the FDIC, and with the establishment of a pure fiat system, I would argue that that was the final abolition of fractional reserve banking, and that in 1971 we moved to full reserve banking in a pure fiat system and abandoned any pretense of any of this being backed by any fraction of gold, right? So I think that fractional reserve banking inevitably fails. I think it has failed — no fractional reserve banking has survived. And it’s funny because Joe Weisenthal — as a troll — he’ll tweet out that no gold currency has ever survived. And I agree! But you have to add: no gold standard currency, right? In the sense of this idea of having a fiat currency that is backed by gold. So I would argue that that has not survived. Gold obviously has survived, right? I mean, you can still go buy gold eagles or whatever and it still has some monetary value. We can debate gold, but I don’t think that’s the focus of today’s podcast!

Stephan Livera: Of course. Yeah, so it’s interesting you say that we are — from a US point of view — living under a full reserve standard, because that conflicts with the idea that there’s legal tender laws and everyone’s forced to accept all the same USD across all of the different banks and this idea that, when loans are created, that’s essentially the creation of new money, and when loans are paid off, that’s the the destruction of the money supply, in a sense.

Pierre Rochard [12:48]: Yeah, I guess my point there is that: when the bank issues a loan, on the deposit side it’s insured by FDIC, and it’s not real insurance because I don’t know of any example of private insurance for demand deposits — it’s always been a government construct because there’s no way to have an actuarial model around it! There’s no way to quantify the risk! It’s actually just a qualitative uncertainty, and so that’s why it has to be subsidized by the government. Now, it’s kind of a deal with the devil in the sense that, in exchange for this FDIC insurance, now those banks have the government breathing down their necks all the time, right? And this is called soundness and stability. That’s like their mantra of: We’re ensuring the soundness and stability of the system. And so you have bank examiners coming into your business and taking a look at your loans and double-checking everything, making sure that you’re not lending out to your uncle at a preferential interest rate or all this kind of stuff — any kind of self-dealing. But they also look at things like FICO scores and risk management. And so now, we have a system where, essentially, credit has become socialized. I mean that in the sense of: 1) the government is allocating credit to specific demographics or specific industries and it’s highly political, because recently it started to get into ESG, right? Of: Hey, are your loans ESG-compliant? Which has nothing to do with the soundness and stability of the banking system! But once you allow political actors to enter into your industry, guess what? They’re going to be political — they’re not just going to abide by what the economics of the situation are. And then 2) socialized as well in terms of the losses, right? When the system does blow up, now the government is going to intervene and is going to bail out the banks, and we’ve seen that happen repeatedly. So that’s kind of the status quo.

Stephan Livera: I see. So then what about the notion of Austrian business cycle theory? So this idea of extension of credit — so, in this analogy where we were talking about the bank extending credit using fiduciary media, as we spoke about — this idea of issuing out tickets above and beyond what it has in terms of an expansion of credit that’s not backed by savings, to use the way Huerta de Soto might speak about it. What are your thoughts around that, and why do Austrian economists believe that this extension of credit causes or creates the business cycle?

Pierre Rochard [16:09]: Yeah, absolutely. So this was much clearer to analyze under a gold standard — under a fiat standard, arguably, there never is any real savings in the sense that, if you were to try to define what is real savings in the system, you’re basically just talking about people who are sitting on hundred-dollar bills as physical currency. That’s the physical in the fiat system, is hundred-dollar bills. And there’s very little of that relative to the number of people who are sitting on fiduciary media in the form of checking accounts! And then you get into like people using money market funds for savings, and people using the stock market for savings, people using bond funds for savings, and all of this. So the fiat standard has been very effective at incentivizing people — through monetary inflation — to not hold money, and to hold financial assets instead, of varying degrees of quality. So in terms of the business cycle: at this point, I would argue that it is entirely driven by government policy! So it’s not even necessarily private economic behavior that is driving the business cycle like it did in the past under a gold standard, where you would have people who would make investments using loans from banks that were creating fiduciary media. And so what this represents is that you are essentially telling the market that there is more demand for investment assets — real investments — than there actually was! And so then as the investment process progresses — at the end of the investment process, they find that there are not enough real resources to complete the investment because those real resources were consumed at an earlier point. And so for example, a great visual of this is building a skyscraper: so you embark on this project to build a skyscraper — it’s 80% complete — and then you realize, Oh, I actually don’t have enough resources to finish completion of this skyscraper. And then the project has to get abandoned or liquidated at a much lower price so that it can be recapitalized and completed, and obviously everyone who invested in that project gets wiped out. And so that’s a really easy tangible example, is the skyscraper example, and there’s actually a great paper on this written by an Austrian economist about how the tallest skyscrapers get built at the end of the cycle, which is basically what you would expect. But that’s kind of a microeconomic example — it happens at a macro level, where the economy gets started on building massive investment projects that are completely unjustified based on the underlying real economics. At this point these cycles, in my view, are driven by monetary policy from central banks, and that is often driven by political considerations of what’s going on with the election cycle. And so one example of this would be when, after 9/11, they decided to ease monetary policy dramatically, and Alan Greenspan was like being very patriotic and he said, Oh I’ll do whatever it takes to keep the economy afloat. It’s like — let’s look at it from a real economics perspective. As tragic as it was, we we’re just talking about two skyscrapers that were destroyed and they were fully insured, and so really the economic damage — we’re talking about a few billion dollars in a multi-trillion dollar economy. There’s not a real reason to say that we need to rescue the entire economy based off of two skyscrapers being destroyed — as tragic as it is. But the politics of it were, Rah-rah — we have to show the terrorists that we’re stronger than they are, so let’s just create a bunch of money and let’s flood the system with liquidity. And I would argue that if we look at the gold price as a proxy for how healthy is the fiat system — that is, that the lower the gold price is, the healthier the fiat system is, and vice versa — that was an inflection point! And I don’t think that it was driven by geopolitical risk that the gold price went up — I think it was driven by, Okay, now the dollar system is not really being managed particularly well compared to what it was doing in the 80’s and 90’s when it was much more tightly run. So yeah, I’d argue that these cycles now — while they still have the same mechanics of traditional Austrian business cycle theory — I think that in terms of their timing and their causal mechanism, it’s a lot more tied to politics because now the entire financial system and the entire monetary and banking system have been captured by political actors.

Stephan Livera: I see. And so in that sense I’m curious where you see a legitimate role for credit to exist? Like, if we were to exist under some kind of full reserve system, what role do you see for credit?

Pierre Rochard [22:23]: Yeah, so hypothetically — I mean, it’s funny because one could argue that if we’re already in a full reserve banking system, then all we need to do at this point is to stop printing money! And so if there was no creation of new money, then we would have a functional fiat full reserve banking system today. And essentially, Paul Volcker almost got there with his money supply targeting at the end of the 70’s and early 80’s, but the temptation is always, Okay, well why would the government do that? Because then that might be fine for the first two years of Reagan’s presidential term, but then he’s like, Wait — hold on, we could actually increase our chances of getting re-elected in 1984 by expanding the money supply and by loosening monetary conditions. So there’s always going to be that temptation from a political point of view. Now, this is where we can talk about Bitcoin, right? Which is that: Bitcoin is saying, Okay we’re gonna have a monetary system where — at the base layer — it’s impossible to create more Bitcoin. So Bitcoin, in a vacuum, is a full reserve banking system where, if you’re holding your own keys, there’s no way for somebody to be creating fiduciary media. Now you might say, Okay, that’s the case in theory, but what if people are using third-parties to hold their Bitcoin and then those third-parties are lending out those Bitcoin? Aren’t we entering into a case of fractional reserve banking? And I think this is an open debate! I think that we could argue both ways because in my view, when somebody is depositing their Bitcoin at a third-party, they 1) really are lending out those Bitcoin regardless of what the Terms of Service say at a legal level, regardless of what the marketing says — Not Your Keys, Not Your Bitcoin, right? Like, that’s, to me — very clear. And I would backtrack into the gold situation and I would say the same with gold! I would say that: when people deposited their gold with a warehouse and received a warehouse receipt and it was all 100% reserve, etc., I’d say, Not Your Atoms, Not Your Gold. So I think that it was the case back then as well. Now the difference between gold and Bitcoin, in my mind, is not the legal contract of the deposit, but it’s really about the fiduciary media and its circulation! We still haven’t seen any kind of emergence of fiduciary media for Bitcoin in the sense of saying, Hey, these are BlockFi-BTC or, Hey, these are Celsius-BTC, and that these are circulating as money substitutes for Bitcoin. And I would argue that the reason we haven’t seen the emergence of money substitutes for Bitcoin is because Bitcoin remains very convenient and very secure — arguably more convenient and more secure than any kind of money substitute or fiduciary media that would emerge! And so what we see instead is that these fiduciary media — if they circulate, it’s only within these platforms. So for example, you can send Coinbase Bitcoin between different Coinbase users, right? If you have their e-mail address, you can send somebody else Bitcoin within the Coinbase platform, which is essentially a SQL database entry transfer. And that exists today, and yet we don’t really see this emerge as something that is seen as more convenient than sending an on-chain transaction. And so I think that it’s going to be really tough for fiduciary media or money substitutes to compete against Bitcoin at a payments level because of the network effects, namely that: Bitcoin is open source, it’s an open network, it’s permissionless, etc., and so in order to join the Coinbase payments network, you have to be KYC/AML’ed, you furthermore cannot run a Coinbase node — you can’t verify for yourself, and we hear stories of people saying, Hey look — I tried transferring these credits within this third-party SQL database and my recipient did not receive it because there was a bug in the software or whatever. And so I think that fiduciary media in the context of Bitcoin — it’s always going to have more risk, more uncertainty, than actually using real Bitcoin, right? And that was not the case with gold! I’d say the reverse was the case with gold, where in practice you had less uncertainty, less risk, by using a gold bank than by actually using physical gold, because you could not do a multisig with gold, because you could not de-materialize gold in the same way that you can with Bitcoin, in the sense that: the reason you would deposit your gold in Italy and withdraw it in France is because it allowed you to travel with a piece of paper, and dematerializing it made it far more convenient. Bitcoin by default is dematerialized, that you can write down 12 or 24 words and you can travel across the Alps with your mnemonic. And on top of that, if you have a multisig, you could maybe have a key in France, a key in Italy, and now you’re still full reserve, you’re still self-custodial, and so you’re really holding the physical Bitcoin, but you’re able to travel with the same level of convenience that you would have with fiduciary media under a gold standard. So, all this to say that I argue that Bitcoin really did make fractional reserve banking obsolete and that we will not see the emergence of paper Bitcoin like we saw with paper gold where people were actually circulating the paper version as kind of a substitute. Now, we could get into Lightning, right? I think that there’s people who will say that, Oh look at Lightning — it’s like fractional reserve banking all over again! I think that’s utterly false. I think that in today’s Lightning Network — maybe in the future things will change, I can only speak about what it is today — assuming your Lightning node does not have any bugs and that you are connecting your Lightning node to your own Bitcoin node, you can verify that the entire Lightning Network is 100% reserve in the sense that every Lightning channel is anchored in the Bitcoin blockchain by an output, and that on top of that, the transactions that have updated the state with your peers, that you’re able to hold those pre-signed valid Bitcoin transactions, and that if there’s any kind of dispute, you can broadcast that to the Bitcoin network and that it will settle and it’s 100% reserve. Now I think that what is fractional reserve in Lightning — and I’m sure people will get into semantic arguments about this but whatever — is the block space! That is that: if we wanted to all close our Lightning channels at the same time and go to the Bitcoin blockchain, you kind of have the same dynamics as a bank run, where everybody is trying to settle on-chain at the same time, but because of the block size limit, they will have to wait. And that can introduce some corner cases of, Okay, what if an attacker gets their transaction in, but the justice transaction is stuck in the mempool very far behind and it takes so long to settle that the attacker actually outruns the timelock? And I think those are great avenues of research — we still haven’t seen any kind of bank run on Bitcoin’s Lightning Network yet, but I would argue that there’s lots of reasons why it might never happen. You know, knock on wood. But yeah, if we’re gonna accuse Lightning of being fractional reserve, it’s not at the Bitcoin level — it’s at the vBytes level!

Stephan Livera: Interesting, yeah. And of course there are areas and avenues of research here, even things like mempool research and ideas like this, but I think to bring it back to the No fractional reserve — this concept that Bitcoin obsoletes fractional reserve banking. Now, there are others — notably, people like Caitlin Long — who’ve made the argument that perhaps there is some form of fractional reserving going on. Now, we’re not going to point the figure at specific exchanges and things, but hypothetically the argument — as I’ve seen her put it — is this idea that: during this recent bull run in 2021 and early 2022, that there were fractional coins or paper Bitcoin, let’s say, and that some people’s demand for Bitcoin was being satisfied by the paper coin on some of these unspecified large exchanges. So I’m curious: what’s your view? Do you agree or disagree with that?

Pierre Rochard [32:52]: Yeah I mean maybe we could get into a semantic debate, but in my view: you can have excessive leverage without calling it fractional reserve banking, because there’s no fiduciary media that is circulating as a money substitute. And so you can have a situation where a business has borrowed too much money, pledged the same collateral to multiple lenders, and that that would be problematic. And if the business told one lender, Hey, this collateral is unencumbered and I have not used it to secure any other loans, but that they have — then that’s just fraud, right? Like, that’s not fractional reserve banking — that’s just somebody defrauding a creditor by pledging the same collateral twice.

Stephan Livera: And just while we’re here on that same topic, could it also be — like, here’s the other way that people are alleging that this could be occurring, and maybe this is fraud and maybe that’s your answer, but — let’s say hypothetically, exchange ABC has 1 million customers and each of those customers believe they have 1 Bitcoin on the platform, but actually the exchange only has 100,000 Bitcoin — you get what I’m saying? So in the way you’re seeing it, how would you characterize that?

Pierre Rochard [34:21]: Yeah I mean I think that those people lent their Bitcoin to the platform and that it just depends on what the Terms of Service say, of whether there’s fraud or not. And also I would argue that — I’m not a lawyer, by any means, but if I put on the product hat — if there’s a disconnect between the client’s expectations and what the website says and what the Terms of Service say, then that’s going to cause problems for all parties involved, because the expectations are not aligned. Now, where that will end up in the legal system or in the economics — the devil’s in the details, but — that’s really where I argue that we have an obligation to tell our retail audience that, Hey look: on any of these kinds of products where you are putting your Bitcoin and sending it to somebody else, you’re entering into an investment, right? You have a cash outflow, and in return, you are receiving an investment product. And it’s going to require some research on your part in order to see if this is an appropriate investment for you. But just because the website says that there’s 1 Bitcoin — that’s where it’s like: you’re creating a false expectation for the user! That is, that: what the website should say is that you have a note, right? A receivable that has a nominal value of 1 Bitcoin that is redeemable for 1 Bitcoin under these certain conditions. And that’s a lot to put on a web page, but if — as a business — you want to maintain your clients’ expectations aligned with your own, then that’s what your website should say! It certainly shouldn’t just say 1 BTC, right? Because now you’re creating a false expectation with your client. And that would be appropriate if, perhaps, you have collaborative custody, and so you’re like Casa or something where now you can put 1 BTC on the website, because there is actually a Bitcoin output that is non-custodial that is 1 BTC, right? Or it’s like a watch-only address or something. That’s a situation where it’s appropriate to put 1 BTC. But if that person actually deposited the Bitcoin with you and now it’s Terms of Service-Bitcoin, well you have to clearly communicate that with the client to not get in trouble later on — not even with the lawyers or anything, but just in terms of your business with the client.

Stephan Livera: Yeah I love the framing there — the Terms of Service-Bitcoin — because this is one thing, that people talk about Bitcoin colloquially. Now of course, we always recommend Not Your Keys, Not Your Coins and you should self-custody — but I could imagine people saying, Oh look, I’ve got 3 Bitcoin on Coinbase, or I’ve got 4 coins over on Binance or whatever exchange, and this is probably an opportunity for people to speak more clearly about things. And there have been moments in Bitcoin’s history where people were very clear about this: so the obvious example is Mt. Gox coins. So there was a time when Mt. Gox was undergoing stress and this was sort of late 2013, maybe early 2014, I can’t remember the exact time, but there was a different price for Gox coins than there were for coins on other exchanges. And that was very clear, and it was seen like, Oh there’s a Gox premium — that’s just a thing.

Pierre Rochard [38:37]: Yeah and we did not see those Gox coins circulate as money substitutes, right? It’s not like you’d go to a merchant and they’d be like, Oh, do you want to pay us in Bitcoin or in Gox coins? And here’s the exchange rate. So I think that those clearly did not devolve into fractional reserve banking, even though people said, Oh now Gox is a fractional reserve bank! I’d argue No! — it’s just it’s an insolvent business where the creditors are trading their liabilities at a discount, and that’s not fractional reserve. And there’s no ambiguity — in my mind, at least.

Stephan Livera: Sure. So then maybe let’s throw a few other examples out there just to clarify for people. So then the way you’re speaking about it: so let’s take the example of El Salvador. So El Salvador — population of about 6.5 million and let’s say 3–4 million of them are using Chivo Wallet, which is the government’s wallet. And let’s say people are depositing coins and they’re doing internal transfers — so I guess it’s the same kind of thing like you were saying, right? They’re just doing internal transfers — that could be a SQL database operation, as far as we’re concerned, but I guess to your point it’s that it’s not that Chivo Bitcoin are circulating outside of the Chivo ecosystem, or if they are, it’s just a Lightning transaction and then it’s just hitting the normal standard Bitcoin Lightning Network and therefore not fractional in that sense right. So just to understand from your point of view: what would it take, then, for it to actually be — like for some day, hypothetically — fractional reserved Bitcoins?

Pierre Rochard [40:24]: Yeah so I mean they would have to build a payment system that competes with Bitcoin and Lightning, and that’s really challenging! The network effects on that are really hard. We could see them maybe try to leverage Visa and Mastercard, right? And we do already see some cards where you can spend your Bitcoin, but I haven’t seen any where it’s like you can spend your Bitcoin but the value of the Terms of Service-Bitcoin is freely floating against Bitcoin, right? It’s generally pegged like a gift card. And I wouldn’t call a gift card a money substitute, per se. In my mind: in order to be fiduciary media, it has to be freely floating — the value can’t just be 1:1. Something’s odd there if it’s 1:1 — either there’s some kind of government backing, or it’s 100% reserve, right? That’s the alternative there.

Stephan Livera: Sure. Probably another interesting example might be let’s say Binance Pay. Now, I don’t know the full details of how Binance Pay works, but as an example I know they have a merchant solution and I believe it’s some kind of custodial system where, again, a Binance customer might be paying at a merchant who’s using Binance Pay and I presume it’s all just like an internal ledger thing, probably similar to Chivo. But maybe that’s a similar idea to what you were saying there?

Pierre Rochard [42:00]: Yeah. And going further, I mean there’s also Binance Smart Chain, where they actually wrapped Bitcoin. I think that it’s BitGo that’s the custodian for wrapped Bitcoin. Now to be clear: I don’t know anything about the situation with wrapped Bitcoin, so I’m not trying to defame them or anything. But one could imagine that if there’s a custodian for a wrapped Bitcoin on Binance Smart Chain or whatever it is, and that custodian is actually holding less Bitcoin than they are representing or that they have issued on the other chain, then now we can be talking about fractional reserve banking! This wrapped asset would be trading at a discount versus real Bitcoin on the Bitcoin network. And then, in my mind, whether it’s successful fractional reserve banking or not would really depend on: is there adoption of this Binance Smart Chain fractional reserve wrapped Bitcoin? Are people actually using it? Is it circulating as a Bitcoin substitute? I haven’t really seen it so far. We’ve seen 100% reserve wrapped Bitcoin on Ethereum circulate as collateral for some of these De-Fi protocols, but yeah — economics aside — it’s obviously a problem in the sense that it’s centralized, that you’re trusting Bitgo with the wrapped Bitcoin in custodianship. But it’s still 100% reserve, so I wouldn’t call that fractional reserve Bitcoin.

Stephan Livera: Of course. And probably another interesting example — although I would categorize it probably more like a full reserve — is Liquid. Liquid is a federated sidechain from Blockstream and I think it’s 15 functionaries. And so the idea is: individuals can peg in a Bitcoin — take 1 Bitcoin and peg that into Liquid — and now it becomes an L-BTC. Now it’s possible to verify every pegged Bitcoin out is equivalent — okay, they’ve got this many Bitcoin that was pegged in and here’s however many L-BTC exists when you’re running a full Liquid node. So I’m curious your view on the economic character of an L-BTC: would you characterize that then as a substitute?

Pierre Rochard [44:23]: I mean as far as I know it’s still 100% reserve, and so I wouldn’t say, Hey, this is fiduciary media. There, you’re trusting the federation to be able to peg out. Maybe the same thing with wrapped Bitcoin? I think it would be similar — it’s a different trust model. If you look at the trust model on wrapped Bitcoin, you’re trusting one custodian. Liquid you’re trusting a federation — same thing with Fedimint, right? We could talk about Fedimint as well — it’s been in the news. I know you’ve done some podcasts on it. Now, what I like about Lightning is that it’s at this opposite end of: you’re not trusting anyone other than your own software and how you’ve configured it with the right timelocks and all of this.

Stephan Livera: Yeah, of course. And so we would say the best level is just on an address to which you control the private keys that you’ve verified with your own Bitcoin full node. Most people would accept that as the most trustless or the most trust-minimized, let’s say. So I’m curious as well then — because people might be thinking, Okay Pierre, if we’re accepting this idea that Bitcoin is obsoleting fractional reserve, what does that mean then for business? Because again, people have grown up in this world of the system where we have this fiat money and they’re used to business funding itself through debt or expansions. So how does that work in a Bitcoin world, in your view?

Pierre Rochard [46:09]: Yeah so first of all they could still borrow Bitcoin, and we do still see a very active borrowing and lending market for Bitcoin. Now I would always caution people that even the people who are borrowing and lending Bitcoin full-time as their profession have had issues with credit going bad. And so if you’re trying to survive in this crazy crazy wild west — Not Your Keys, Not Your Bitcoin, right? Don’t lend out your Bitcoin! You should put them in cold storage and let the professionals try to work out how does the lending and borrowing work and getting wrecked and all this. So I’d really caution people to be very very weary of any kind of product where you’re gonna send your Bitcoin to somebody else versus holding it in cold storage. The other part of it is: if it’s the case that the professionals are getting wrecked on credit, is it because it’s impossible to have any kind of investment where the return of the investment is greater than the cost of capital? — of the interest rate paid to the lender? I think maybe that’s the case while Bitcoin is still so volatile because of where it is on the adoption curve, and that longer-term, when things settle down, that there will be investment opportunities where credit will make sense. But I also think that this idea of putting your money to work and investing is very fiat and that people have been forced into it — as I mentioned earlier on the pod — due to inflation, and that perhaps not everyone should be investing. And in fact, I would argue that what makes sense to me is that investing will be driven by utility. And what I mean by that is: Okay, what’s the utility of investing if we remove the speculative, Okay I’m going to earn a financial return on this? Well for one, if you are looking to make income, it makes sense to own your own business so that you can control how you do your work, and that’s the utility of owning equity in your business! It’s not that you’re trying to make money off the equity — it’s that you’re actually trying to control your own destiny and do things your way. So I would argue that that’s a fine reason why you would want to own the equity in your business instead of owning Bitcoin, right? Because the alternative is: you could sell your equity to others who are not smart enough to realize that Bitcoin is a better allocation of capital. So I think that there’s that aspect of it. Same thing with real estate: the reason that you would want to own your own house and own the equity in your house instead of renting your house, for example, is because you don’t want to get evicted when the property developer decides that instead of renting they’re going to knock it down and build a skyscraper. So again, it gives you control. And controlling an asset is utility, beyond just the question of: Are you going to be able to sell it for a higher price in the future? Or: Are you going to be able to earn a cash flow on it? So that’s where I think that investing will go is that either you’ll have people who are investing their own time and money into building up equity — and equity is like: even if the value of the equity goes down long-term, you still derived the benefit of controlling the economic entity, the corporation or whatever it is — the partnership. And so it’s not like you actually had a loss because you have to add up the intangible utility of having been able to make the decisions in addition to the salvage value of the economic entity at the end of the period. So yeah, that would be my argument for why you could even have negative returns and people would still want to own equity.

Stephan Livera: You heard it here first everyone: Pierre says your house is a utility coin.

Pierre Rochard [51:14]: It is! It absolutely is! And that’s why I really think that it needs to be demonetized. Now, people are owning real estate in order to sell to the greater fool who will pay a higher price. And in my mind, this is all driven by the fact that the government is subsidizing the mortgage market. The 30-year mortgages and interest rates are set by government policy.

Stephan Livera: Yeah I definitely agree that there’s been a lot of institutional subsidy, or just the way people think about it — it’s cultural as well: different countries around the world. Australia has a very strong property cult.

Pierre Rochard [51:55]: Yeah well just the thought popped into my head with regards to the issue of monetization of businesses — it’s the same as with real estate, where large corporations are subsidized by the money printer. They get preferential access not only to bank loans but also to equity markets, and this actually is a problem for people who are trying to start their own business, because now you’re competing for labor, for capital, for real resources against people who have an artificially lower cost of capital. And in my mind, that’s why entrepreneurship and being able to start a small business has gotten harder over time, versus under a Bitcoin standard it’ll actually be a lot easier than it is today, because 1) you’ll be able to work for somebody else, save up money, not have to invest it — just save up money for a few years — and that’ll be enough to capitalize your business! You won’t have to save money for 10 years or 20 years to do a startup — you could save money for a few years and do a startup, because all of the investment assets that you will be paying for, whether it’s a computer or real estate or whatever it is, will be much less expensive in real terms. And so it’s going to be, in my mind, a much more dynamic economy than it is today where you have these ossified large businesses that profit at the expense of small entrepreneurs.

Stephan Livera: I agree with you definitely, Pierre. And I think the other point to add would be: the world today allows politically connected people to be gatekeepers of capital, and nowhere else do we see this. Even now we’re talking about ESG, right? So they are gatekeepers, and nowadays if you’re a young person and you’re trying to get capital to start a business, you have to go through the gatekeepers, and then if you want to borrow money from the gatekeepers then you have to kowtow to their ESG line or whatever other ideology of the day. Whereas in a Bitcoin world, it’s perhaps more so that you could just save up your money and just start up your business. And so I think those are some of the things that people who are listening today are thinking, Oh hang on — how are we going to work in a Bitcoin full reserve world? Like, my business relies on credit — I wouldn’t be able to run it or I wouldn’t be able to start a business! Well I think part of the answer is: costs of a lot of other things are going to come down, so: property costs, the cost of goods, right? So this idea of growth deflation, as Joseph Salerno puts it, or Jeff Booth would call that technology deflation or the good deflation — we’re going to be living in that kind of world, and so I think we can summarize it a bit like that. And as you were saying, Pierre, perhaps to that question of why aren’t we seeing Bitcoin credit markets now — part of the reason of that, at least as I would see it, is that Bitcoin’s return has just been so incredibly high that it’s been very difficult for any person, any business, to actually outperform Bitcoin returns. Maybe only a very few — some of the exchanges, maybe. Maybe some of the early miners have outperformed Bitcoin. But other than that, it’s just incredibly difficult to actually outperform Bitcoin as a Bitcoin entrepreneur, and that’s why so many have tried and failed.

Pierre Rochard [55:22]: Yeah and even if you have a situation where they outperformed on paper financially, the bottom line is that the person who was holding Bitcoin in cold storage had the utility benefit of: no counterparty risk, liquidity at any time — they could sell their Bitcoin much more easily than they can sell private shares, for example, they are able to run their own Bitcoin nodes. They can’t run a node that says, Oh here’s your equity stake on the cap table for this startup or whatever! So if you’re an employee at one of these companies, you can turn into like golden handcuffs where you’re not able to leave the business because you’re tied to the exit or whatever it is. So I think that there’s lots of utility arguments for why if you adjust for the utility of having held [Bitcoin] in cold storage with your own node for 10 years, that now Bitcoin has outperformed any other investment or any other financial return. Yeah, on the gatekeeping point too, people who say like, Oh I wouldn’t be able to have my business without bank credit — well that just means that they have a business that fits into the template of a bank loan officer and what they are willing to extend credit to. But if you have a business that is like a crazy idea that no bank would extend credit for — and quite often those are like the most innovative and most successful businesses — then you’re shut out of the credit market. And so I think that being able to self-finance by saving up money is actually much more powerful because it allows people to pursue ideas that nobody else believes in. Whereas in the credit system it’s like, Hey, you better have a proven idea where we’ve seen other people succeed with this. I would argue this is the rise of franchising of: now we have this generic capitalism where it’s just all the same stores and all the same restaurants in every town — that that’s also subsidized by fiat.

Stephan Livera: And another factor to add here — and to just consider for listeners — is the unseen. So this is something that Austrian economists and people talk about — Henry Hazlitt, Frederic Bastiat and all these people talk about this — even recently, people like Per Bylund have spoken about the impact of regulations. And the problem being: some of these regulations and gatekeeping and things, and control, are stopping businesses that otherwise would have come to fruition and we would otherwise see them today. So — absent this fiat control over the money system — we might see a much more vibrant economy today! We might see all these businesses and different ways of operating, and maybe technology advancements, that we wouldn’t have otherwise had if it didn’t all go into financing all these random VC [funded] failed projects.

Pierre Rochard [58:29]: Yeah absolutely. I think that VCs have their place, but I think that they’ve become overvalued in a fiat system relative to what they ought to be.

Stephan Livera: Yeah so I think it will bring power back to individuals who are able to be judicious and able to save and have that value of thrift — being able to produce more than what they are consuming — either as a business or whether they are doing that as an individual. In either case, I think Bitcoin brings a certain level of discipline to the market and to all of us, really, that we have to learn to operate within that frame. And that discipline in turn will create a much more vibrant market economy, is how I’m seeing it at least. I’m curious if you agree or disagree?

Pierre Rochard [59:18]: Yeah I completely agree. I think it also adds to the consumer sovereignty part, where we’ve seen businesses that essentially can survive off of investors, right? Where investors are adding more and more capital because they’re getting this capital basically for free from the fiat system, and that means that the business — its future is not really tied to consumer preferences as much as investor preferences. And so we’ve seen the rise of woke capitalism and things like that where we’ve got companies that are insulting their consumers instead of treating them like kings.

Stephan Livera: Yeah so one other question I’ve got for you actually, just while we’re kind of on this whole topic of fractional reserve, full reserve: I’m curious what you make of these arguments around the Eurodollar system — so this system outside of the US. Because I guess traditionally, Austrian economists have looked at things like M0, M1, M2 and said, Oh look, you’re pyramiding up debt — this is causing the business cycle. But there’s this whole question now of these Eurodollar markets that are just mostly outside the purview of US regulators, US government, and perhaps that is also another unknown factor or unknown variable in the money supply. So I’m curious your take on that: How important do you think that is in terms of assessing the fiat money system as we see it today?

Pierre Rochard [1:00:56]: Yeah absolutely. So I think that now we might be getting into actual fractional reserve banking that still exists today. But in financial crises, what we see in practice is that the Fed bails out the world, right? And I would go further than Eurodollar — I would say every other fiat currency arguably is a dollar-substitute, and is kind of a freely floating dollar-substitute. Now as of late, we’ve seen the euro and the dollar essentially get to parity — and this gets to why the dollar is the world reserve currency, is that: the monetary policy that comes out of the United States, out of the Federal Reserve, determines the monetary policy for the entire world. And so if the US is tightening monetary policy or loosening monetary policy, that has knock-on effects for every other central bank and thus for every other financial system, every other economy throughout the world, which in my mind is like the most undemocratic thing ever! Because not only do Americans not vote for who heads the Fed — because the Fed’s independent or whatever: we can debate how much influence the President has on the Fed and whatnot! There was some interesting back-and-forth with Trump and Biden on that. But that aside, these people in other countries — they don’t vote for the US president, and yet the US president is going to appoint who ultimately controls their monetary policy. So yeah I’ll let the macro talking heads point out the specific tie-ins between Eurodollar, the domestic dollar market, and all the other foreign currencies, but it’s a giant pyramid scheme, and it’s all back-stopped by the Fed. So we saw during the last financial crisis they had these secret currency swaps worth hundreds of billions of dollars, trillions of dollars, with all the other central banks. Now, how tightly coordinated is that? Is it the WEF or is there some kind of Bilderberg group or whatever? Or is it just they’re on Whatsapp texting, Hey can you send me some money? We’re about to go bust. Clearly there is coordination between the Fed and all the other central banks because they understand that there is mutually assured destruction in the sense that: if you have one of the legs of the ponzi scheme go into a deflationary cycle, that that has a contagion effect on the rest of the system.

Stephan Livera: Excellent. And one other area I wanted to touch on that just came to my mind now is this question around denomination. So obviously, as countries get into trouble around the world, what we’ve historically seen and even today what we see: some of them dollarize. Now part of our thesis as Bitcoiners — as Daniel Krawisz all those years ago wrote the Hyperbitcoinization article and Conrad Graf also mentioned this idea of hypermonetization — is it then a problem for the Bitcoiner thesis that there’s not a lot of people denominating prices in Bitcoin terms? Because as we know today, there are a few who would do this today. Like typically, it’s US dollar pricing and then they just convert at that time — okay, this is this many sats. So I’m curious from your point of view: is that an issue? Or is that more just like a That will just come later down the track?

Pierre Rochard [1:04:46]: Yeah so I’d say there’s probably at least three demographics today that are using Bitcoin as their unit of account. So you’ve got 1) miners because they’re thinking about Do I buy Bitcoin or do I buy a mining rig? Because those future cash flows are denominated in Bitcoin. You have 2) altcoin traders who will often look at their portfolio and benchmark it against Bitcoin and see if their trading is outperforming Bitcoin. And then you have the 3) hardcore Bitcoin maxis who are really looking at everything — well obviously they don’t have an altcoin portfolio but hypothetically speaking — they’re looking at all their assets, their entire balance sheet, and looking to see what’s going to outperform Bitcoin? Well — nothing! Nothing is going to outperform Bitcoin! And so they are selling their chairs, selling their cars, cutting their own hair, because they are using Bitcoin as their unit of account and they’re realizing that it’s in their self-interest to maximize their accumulation of Bitcoin. So I think that, as Bitcoin grows, the number of people who are using Bitcoin as their unit of account will grow. It will hit an inflection point at the same time as store of value, medium of exchange, hits an inflection point. Because I think that those three monetary properties — unit of account, medium exchange, store of value — they are different facets of the same thing, of monetization. And so I do think that they grow at the same time even though you’ll hear people talk about which one comes first. If I were to rank order them, I would argue that unit of account comes first because, in order for somebody to want to acquire Bitcoin, they have to think about it as, Okay well this is going to outperform. And once you’re making the argument this is going to outperform, well now saying that you should have any other asset on your balance sheet really becomes a question of risk management, not what is your unit of account. Now I think that by default, Bitcoin is your unit of account, even if you’re not consciously aware of it. And then second: medium of exchange, because now in order to acquire Bitcoin, you have to trade with somebody else, right? Now, whether it takes the form of mining or whether it takes the form of going to a KYC exchange or earning it with BTCPayServer, you’re engaged in a transaction in order to receive the Bitcoin. And then you can finally use it as a store of value because you put your Bitcoin in cold storage. So I’d argue store of value comes last and that it starts at the unit of account, goes through medium of exchange, and then goes to store of value. And really what we’re arguing over is: how conscious are people of it being used as a unit of account? And then: How often are people using it as a medium of exchange versus a store of value? Because once you’re sent to cold storage, now you’re continuously using it as a store of value every second of the day, right? Every day of the year. Whereas you’re medium of exchange, you might only use it weekly because you’re doing a weekly DCA. And so it’s just a question of frequency rather than a question of which comes first.

Stephan Livera: I se, yeah. And I think definitely it’s an interesting exploration of the journey that a typical Bitcoiner goes on, because in many cases people might start with they’re just dipping their toe. And then eventually they sort of up that and say Oh look actually yeah I want to hold more of this! And then eventually they get to this point where it’s, Okay it’s my savings. And then eventually it’s your unit of account. Some say — like, Francis Pouliot is very public about this on Twitter: he’s very like, No, I just think of everything in Bitcoin terms — it’s all about how many Bitcoin and how many sats I can earn, as probably more long-time Bitcoiners can relate to, because that’s just how they’re assessing things in terms of: Do I invest in this thing? Do I do this action or not? Will it result in more or less Bitcoin?

Pierre Rochard: Yep, that’s exactly right.

Stephan Livera: Yeah okay, well I think that’s probably a good spot to finish up there. So I think we’ve explored a few of the ideas around fractional reserve, full reserve — what it looks like. So yeah I think we’ll leave it there. So listeners: make sure you go and follow Pierre. It’s @BitcoinPierre, so guys go and follow Pierre. And Pierre, I really enjoyed chatting with you. Thank you for joining me.

Pierre Rochard: Yeah! Thanks for having me on, Stephan.