Bitcoin Blog a1

Tuesday, April 12, 2016

Bitcoin Banking?

I have recently made an account with BTCpop.co. The site has some interesting features, one is its peer-to-peer lending options. People ask for a loan for various reasons and the people that want to fund these loans do so. In addition to loans, BTC pop also offers a 5% savings account as well as some IPO services. I want to focus on the bank like aspects of BTCpop today.

This method of lending has some interesting risks associated with it. The largest risk to these loans is credit risk, or the risk that lenders will not pay the money back. This is universal to essentially all loans (except some government bonds). These loans also carry some interest rate risk and inflation risk; however, this is quite small due to the short-term nature of these loans.

These loans also have many features not associated with similar commercial loans. One is transaction risk, the risk that the bitcoins you used to extend the loan are worth less than the bitcoins you receive at the end of the loan. This is longer than normal because it takes time to exchange bitcoins for regular currency.

In addition, these loans carry an “institutional risk” or the risk that the website/institution will fail.  In this case, the loan makers may not see any of their money.This risk is the primary risk of the 5% savings account. If the institution as a whole fails, you will not get your money in your savings account.

This savings account also has more risks associated with it than a regular savings account. As long as the bank has enough bitcoin reserve to pay off withdrawal requests, there is no problem. However, if depositors want their money bank and the bank doesn’t have enough reserves, then the bank faces a liquidity crisis. Regular banks have a few tools to avoid this problem. They are able to loan money to each other, so if one bank has excess reserves, they can lend it to another that is lacking. They also are able to borrow directly from the Federal Reserve, or the appropriate central bank.  Banks also engage in the repo market, there they give securities (like bonds) as collateral on a short term loan. It may be possible for this bitcoin bank to translate on the repo market. But that still leaves the institution with only one of the 3 tools regular banks have to handle liquidity issues.

Also, the overall risk of the bank is very likely tied to the overall credit risk of its borrowers. The bank almost certainly invests its deposits in loans to people on the site. This also means that if enough  borrowers default, the institution is at risk. So even if you have not lent money directly, by putting it in the bank's savings account, you still may lose your money. Its also important to note that normal banks are insured by the FDIC for up to $250,000. However, this bank offers no such protection. This means that the bank's approach to risk is even more important than normal.

All of this addition risk seems to be rewarded. User initiated loans have rates that at crazy even by payday loan standards. The site’s savings account offers 5% compared to less than 1% at commercial banks. The difference in rates is so great, I don’t think all the loans follow the Security Market line in the way that they should. However, that is an issue for another day.

2 comments:

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