Blockchains, Reserve Bank Accounting, and Unbalanced Liabilities

Blockchain enthusiasts have occasionally claimed that blackchains allow “an asset without a liability,” a phrase used by Walker and Luu, and echoed by Nic Carter. Despite being a ledger, the blockchain is not money owed by anyone — which is a informal understanding of what a liability is. The claimed advantage of this seems to be that cryptocurrency holdings are akin to a natural resource, like gold or silver, rather than a reserve-bank backed fiat currency.

In many ways Bitcoin and similar ventures do resemble such assets, or even exceed them in important ways. For example, the supply of Gold is “fixed” — modulus mining, which can increase when gold prices are high. The supply of bitcoin, of course, is fixed in a much less manipulable sense. However, not having a corresponding liability is not one of the ways that cryptocurrencies differ from reserve-bank currencies — in fact, it is an incredibly close parallel.

First, it is useful to understand what a reserve bank balance sheet does — it has assets, which are things it purchased, and liabilities, which is principally the money that has been issued. Reserve banks function by running a liability-focused balance sheet — they create money from nothing, which gives them an asset, the money created, and a corresponding liability, which is that the money is actually a debt to itself. If this money is used to buy something, they get an asset in exchange for an asset and the balance sheet balances. But the liability doesn’t mean they owe anything — they can leave the currency issued and never repay it.

If I have a $50 bill, that is a direct $50 liability on the part of the central bank. They don’t owe me anything, but it’s a liability. The way those liabilities are balanced is via a negative equity — the total government debt. That’s because in most cases, central banks are actually paying for things that they don’t receive — the government runs a deficit, and the excess payments by the government creates a debt, which is again, a reserve bank liability. The theory is that the reserve bank could always balance its books by having the government tax to pay for all of those liabilities — but the more common resolution is inflation, insolvency, and often abandoning the currency.

This is fundamentally different than a commercial bank. If I have $50 in a commercial bank, and no debt, that’s a $50 liability that the bank owes me, and a corresponding $50 asset that they have to lend. The money is ALSO a liability on the reserve bank balance sheet, corresponding to the asset the bank has. The bank’s balance sheet for these assets needs to balance, however, unlike the reserve bank. If they hold the cash, they can then lend my $50 (in fractional reserve banking, to three or four people,) but for every dollar they hand out, they gain a corresponding asset — that someone owes them the money. They can become insolvent just like the federal government — if too many people default on loans, they run out of money, and (if the FDIC or equivalent doesn’t step in,) the depositors lose their deposits.

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How does a blockchain work? Just like a reserve bank, it gives out money (pre-mined tokens, block rewards, transaction fees,) but it does not get anything in exchange. This is a lot like when a government overspends its assets — the corresponding liabilities turn into money. Here, however, the item purchased with the money isn’t an asset, it’s an intangible — security and transactibility. Until the currency is fully mined, every block mined costs the network money to pay for this security and transactibility.

When I have a bitcoin, it’s an asset balanced by a liability held by the blockchain. Whose liability? It belongs to the network. The network must mine more blocks to allow transactions, and keep these liabilities useful —and this is an ongoing expense.

Cryptocurrencies have associated liabilities, just like any other asset that gets issued. What balances the block-chain debit-sheet? Nothing — just like central banks, which spent money and created liabilities. Unlike central governments, blockchains don’t have the ability to tax to re-balance the balance sheet. By design, of course, most also can’t inflate the currency. If for any reason the blockchain is unable to meet the ongoing expense of mining rewards to provide security and transactability, it does exactly the same thing a reserve bank does, and the money disappears.

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