In this Bitcoin study session, Lucas and Grant discuss chapters five and six of Lyn Alden's "Broken Money," covering proto-banking systems like Hawala and the rise of modern banking with double-entry bookkeeping.
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Summary:
In this session, we discuss chapters five and six of Lynn Alden's book "Broken Money," focusing on the evolution of banking.
Chapter five introduces the Hawala system, an informal value transfer system that predates modern banking. The Hawala system involves a network of brokers who facilitate the transfer of funds between individuals in different locations without physically moving the money. The customer gives money a password, and a specification that the money be given to customer B, who's in another area.
That customer A's area then communicates in the other area that password. This system relies heavily on trust and reputation and maintains individual ledgers of transactions.
The Hawala system's decentralized nature makes it difficult to control, leading to scrutiny over its potential use for illicit activities. However, it also provides a means for individuals in unbanked regions to transfer money across borders efficiently.
Chapter six delves into the rise of modern banking in Italy, particularly focusing on the innovation of double-entry bookkeeping. This accounting method splits ledgers into assets and liabilities, enabling more complex financial services. Bankers, initially sitting on benches (bancos) in merchant squares, maintained ledgers for merchants, facilitating transactions between them. This led to the development of paper instruments like banknotes, which enhanced gold's portability and liquidity. The system's negotiability allowed for the transfer of paper instruments to different parties, further increasing convenience. However, this abstraction also increased counterparty risk and the potential for fraud. As banking evolved, fractional reserve banking emerged, driven by competition among banks for deposits.
This practice involves lending out a portion of deposited funds while maintaining a fraction as reserves. While it can stimulate economic growth, fractional reserve banking also introduces instability and risk, as banks may not have sufficient liquid reserves to meet depositors' demands during a bank run.
The discussion highlights the benefits and drawbacks of various systems for facilitating payments and storing value. The speakers noted that the Hawala system's decentralized structure and reliance on trust offer advantages in terms of efficiency and accessibility, but also pose challenges in terms of regulation and oversight. They also noted that modern banking's centralized nature and reliance on fractional reserve lending create opportunities for economic growth, but also introduce risks of instability and moral hazard. The conversation touches on the layers of abstraction that have been added to commodity money over time, such as legal tender coinage and negotiable paper instruments, and how these abstractions can be manipulated by centralized authorities.
In this context, the speakers compared Bitcoin favorably to fiat money in that Bitcoin is a hard asset that can be transacted peer-to-peer, thereby eliminating abstraction.
The participants also discussed the tendency toward increasingly risky fractional reserve banking and how government bailouts can exacerbate moral hazard. They criticized the FDIC's flat-rate insurance premiums for banks, arguing that it incentivizes risk-taking behavior. In summary, the study session provides a comprehensive overview of the evolution of banking, highlighting the trade-offs between efficiency, stability, and control in different monetary systems.
Our next discussion continues with chapters seven and eight.
