Partial Reserve
The beginning of money was shiny metals. Then there were pieces of paper that represents the shiny metals. Then there was nothing. And nothing works when it is next to something. If something has a great deal of value or assurance, people will be content with nothing, at least for a little while.
Example: Nothing Next to Something
We are literally losing our minds over points hoping that they translate to airdrops at some point in the future. If that isn't nothing next to something, I don't know what is.
Expansion
Fractional Reserve Banking is very simple. If you have 1,000 USD in deposits and your reserve rate is 50%, then you can lend out 500 USD at x% interest, and pay the depositor and keep the rest. You effectively expanded the money supply by 50% for the life of the loan.
By playing with the reserve rate, you can expand the money supply at your leisure, at least until the chickens come home to roost.
Allocation
That 500 USD that was lent out can be sent toward bold innovation or precarious chicanery. This is up to the managers of the money. In the best of times, these monies have gone toward some of the world's best innovations and in the worst of times it goes to consumption. Regardless, in true capitalism some of the money will be lost, some of it will grow 20, 40, 60 or even 100 times. The innovations of the Industrial Age were principally because of wise allocation.
Liquidity
The 1,000 USD is important to note. Only 500 USD is actually in the bank. How does the bank manage this? Rates of interest. The interest rate must be high & feasible. High enough to convince the depositor to refrain from withdrawal & feasible enough to where the depositor believes the interest will remain intriguing for the foreseeable future.
This equilibrium maintains the deposits and limits the banks desire to endanger itself. No bank would like to pay more in interest than they are making, so they attempt to move with prudence to maintain deposits.
Caveat Emptor
Under the current banking structure, all deposits are effectively backstopped by the central banks of the world. This permits banks to take on much more risk because they don't have to worry.
This is not the same in cryptocurrency, and it shouldn't be. Moral Hazard is a general issue in traditional finance that should not infect the likes of decentralized actors, because if it did, the degeneracy that would ensue would be like none other.
Why do we need it?
In the current form of cryptocurrency, we await to see Stable Coin market cap increase before we call a bull market's beginning. This is a great metric but also a mark on our dependency on fiat currency. Without the approval of centralized actors, we wouldn't be able to fuel decentralized finance.
Frax depends on USDC. DAI depends on USDC, and US Treasuries. Gho is backed primarily by Liquid Staking Tokens. Grai is only backed by LSTs & Ether. However they are not fractionalized.
Fractionalization would permit the ability to expand the supply far easier than the current model which requires more ether (limited in supply) or increase in prices (likely only in bull markets). The truth is we need a new way to think about money that is sourced from DeFi, natively.
Collect this post as an NFT.
New blog by @augustuscaesar analyzes the history and role of money, from shiny metals to paper to 'nothing' backed by trust. Discusses fractional reserve banking, allocation of funds, liquidity, and inherent risks. Calls for a new way of thinking about DeFi native money.