Calling All Hackers: How money works (2024)

When your deposits are denominated in _current_ dollars, and that's what your customers can demand, then it doesn't matter that your expectation of how many dollars you are going to receive in 2035 is stable. It's about what our assets are worth right now, in case you need to liquidate them to satisfy withdrawal requests.

If you can contrive your deposits to be denominated in 2035 dollars, then long term treasury bonds are 'stable' in that sense.

Similarly, if your deposits are denominated in grams of gold, then gold is a stable backing for those.

If you have a mismatch between what you owe and what you own, then you need a thick equity cushion between your assets and fixed liabilities.

> No, you don't get it. Imagine if there was a single bank and no cash withdrawals. The bank can't run out of liquidity, ever. If you buy something from a company, the money lands in the bank account of the company, which is managed by the same bank. This means as long as there is no cross bank transfer, there is no limit to how much money can be created.

Yes, monopolies are bad. I completely agree with your analysis here. That's one reason why central banks can get away with so much.

> But here is where it gets weirder. Imagine if there are two banks now. Surely now the idea presented above breaks down the moment there is a cross bank transfer, right? Except it's not that simple. There is merely a limit to how much of the created money can leave the bank in one direction. If the cross bank transfers are balanced so that for every transfer from bank one to bank two, there is a transfer from bank two to bank one, then you are back in unlimited money territory.

Here's where it gets interesting.

Assume there are n banks. Let's also assume for the sake of simplicity that transfers behave a bit like Brownian motion. That means on average we don't expect any bias in transfers between banks, but we also expect some random variance.

Say, our banks settle their net transfers at the end of the day. With a bit of math, we see that the expected variance for any bank proportional to something like gross transfers of that bank, and thus the standard deviation is proportional to the square-root of gross transfers. (It also depends on n.)

Our commercial banks settle by exchanging reserves, eg central bank base money or perhaps they ship physical gold. We can assume that they want to avoid being short of reserves when it comes to settling, but it's not infinitely, and holding reserves costs money. So in practice they'll settle on some multiple of the standard deviation as their precautionary reserves. If the amount of total reserves in the banking system is fixed, that'll place a limit on how much banks will want to expand their total balance sheets.

See https://oll-resources.s3.us-east-2.amazonaws.com/oll3/store/... for more on this topic and a better analysis.

The above was about reserves and how demand for pre-cautionary reserves limits the size of the aggregate balance sheet of all banks.

Now the other question is: why do banks bother with deposits?

So, let's assume that our bank makes a loan to a customer: they create a deposit / loan pair out of thin air that adds up to zero. Now the customer spends that deposit. On average we can assume (n-1)/n parts of the deposit go to other banks and 1/n stays with the originating bank (by the assumption that our average bank has a market 1/n market share.) Those (n-1)/n parts get transferred to other banks, and thus they drain our reserves in the settlement at the end of the day.

If we can attract enough deposits, we can make up for that outflow and have a nice 0 in the net settlement.

The above is all assuming there's no regulation that requires a specific amount of reserves or capital etc, and it's all set by each bank purely by commercial necessity. You are right that there's no one fixed limit, but the limits are also not arbitrary.

Instead of attracting deposits a bank can also sell of the loan it just made. Or it can borrow and use that loan as collateral. But economically, that's all basically equivalent to a deposit in different guises.

About liquidity: in a functioning modern economy, as long as you are solvent you can always get liquidity. (But conversely that means that your counterparties will treat any liquidity problems they see with you as signs of underlying solvency problems.)

You might also like https://www.cato.org/blog/diamond-dybvig-panic-1907 (or https://archive.is/uRtmw) on bank runs.

« If you intend to hold a bond to maturity you could totally book all the future coupons and capital gains as an asset up front, it's the same thing at the end of the day. »

You conflate 'r' (the discount rate) with 'Rf' (the risk-free interest rate). In reality, for high-risk assets like startups, 'r' is defined by the Weighted Average Cost of Capital (WACC) or CAPM: r = Rf + Beta(Rm - Rf).

Even in a ZIRP environment where Rf -> 0, the Beta (risk/volatility) for a startup is massive. A rational investor would still demand a high 'r', leading to a low valuation. The fact that VCs ignored this and funded "blatantly bad deals" cannot be explained by low interest rates alone. It is better explained by the information asymmetry a.k.a principal-agent problem.

We have a system where capital flows from passive LPs through multiple layers of rent-seeking intermediaries (VCs, LPs, Fund Managers) who are incentivized by management fees rather than carry. The market failure described isn't "financial nihilism" and "financial short-termism". It's a breakdown of feedback loops where intermediaries face no downside risk for misallocation. When there is no market coordination, no real competition, just unrestricted collusion, then things start to not make sense from the old school financial/business perspective. I do not think this is the failure of economic theory or the financial models itself, rather just that nobody knows or tells, that the prerequisite for these things is at least some degree of fair competition, market based economy, informed, rational actors and restricted collusion.

Suggesting that technical founders can fix this by simply "being decent" ignores the systemic reality. This economic structure rewards extraction over value creation, "decency" is an evolutionary disadvantage. The "real hackers" in this story are the financial and business intermediaries who successfully reverse-engineered the economy to extract rent without generating value, similarly to all those entrepreneurs, CEOs, corpo drones in the business sphere who do not provide any meaningful value to society (and shareholders as well.)

In avg, the normal way it creates the liability over time and i would argue that in a colloquial its absolutly fine and doesn't change the message at all.