Banking System vs Bitcoin

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So how does our banking system work, and why does it always keep crashing?

To learn this, we have to go back a bit. 

Banks began by utilizing a fixed amount of resources - that is, they had to back-up all the paper notes they had given out. This means that if they issued a $5 note, they had to have $5 in gold or other resources to back it up. People could go to their bank at any time, and trade their notes for a physical resource. 

In the late 1600’s, fractional reserve systems came into existence. These systems meant that the banks did not need to hold 100% of the value they loaned out, only a fraction. In 1970, the United States removed the gold standard - this means that the US Dollar is no longer fixed to a certain amount of gold. In essence, currencies such as the US Dollar are now free-floating and are backed by a very marginal amount of physical resources. 

This has allowed banks to loan out and issue far more money than before - allowing a select few banking executives to also manipulate currencies and the global market. 

This system has a number of issues.

One, it isn’t very secure. Before, a bank could back up all of its debts. If someone wanted to withdraw their $10,000 in savings, the bank would have that on hand. Now, banks can loan out far more than it actually holds - which means if everyone tries to withdraw their money at the same time, the bank would fail. This is called ‘a run on the bank’, and we have seen numerous examples of this across the globe in the past decade, even in places such as the United Kingdom. A run on the bank was one of the reasons that the Great Depression was so great.

The second problem is that this system of constantly loaning out more money leads to the continuous creation of new money - this in turn leads to inflation. With more and more money created and issued, things begin to cost more. If wages fail to keep up as they have, people begin to lose out. This is why our parents could work at the local grocery store and afford college, a car, and a house - but today young adults can barely pay the bills. 

An inflationary monetary system is inherently problematic, and this is compounded by the fact that only a few banking executives have all the power, and that they lack the resources to back all their loans.

Bitcoin - The Solution

This is where Satoshi sought to create a long-lasting solution. Bitcoin is inherently deflationary, and individuals cannot loan out Bitcoins unless they are 100% backed. 

We’ve previously mentioned that miners contribute to the bitcoin network - verifying the ledgers and processing transactions, and in return they receive newly created bitcoins. The amount of bitcoins received decreases every four years - limiting supply. This is how bitcoin is deflationary. As the number of bitcoin users rise, and the number of new bitcoins issued falls, the currency becomes increasingly scarce. This raises its value - and is one of the arguments on why bitcoin will always rise in value. This means that while a Pizza once cost 15 Bitcoins, today it costs just 0.0025 bitcoins. This is what makes it deflationary, a decreasing supply as opposed to an increasing one.

Bitcoin must also be backed. Users cannot loan out Bitcoins without the transaction being verified by the blockchain network.

For example, if I say I owe you 1 Bitcoin on the network, this is communicated and processed through all the miners on the network - and they verify that I possess this Bitcoin and it is now owed to you. Instead of banks, who can loan out more than they have - Bitcoin users can only loan out what they have. This eliminates the instability and lack of security seen with our current banking system. People could start to write notes of IOUs, and trade those without having backups, but when using Bitcoin directly, it’s impossible to give out more than you have.

All of these attributes are locked in the code that makes up Bitcoin, and it cannot be changed unless a majority of miners around the world agree to change.  This makes the system a democratic system, open to change.  At the same time, no person has control over the entire system, which makes it far more immune to manipulation.

Bitcoin is therefore a stable, secure solution to the problems of our current banking system. Users cannot loan out more than they have, it is inherently deflationary, and the rules cannot be changed by a few corporate executives to suit their interests.