Bitcoin basics - no credit risk

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The biggest financial impact of bitcoin is that money can now be held without taking credit risk. Our financial system is built on a base layer of mandatory credit risk. Everything sits on an interwoven fabric of instability. Bitcoin solves this problem with the option to self custody funds. 

Prior to bitcoin, savers had no practical choice but to deposit their money into a bank. The act of placing the money at the bank reduces the risk of theft, but it creates credit risk. This risk is either borne by the depositor or taxpayers through a governmental guarantee.

With bitcoin, individuals and institutional savers can keep custody of their funds directly on the bitcoin blockchain. They can even set up escrow arrangements to facilitate collateral agreements. They don't have to subject their money to credit risk unless they are presented with an attractive opportunity to do so.            

Below are a few benefits of such a system.  

Cleaner risk - Banks muddy the water when it comes to risk. It's hard to do a trade that isolates a particular risk if money must be held at a bank as part of the deal. This risk may be ignored in good times, but it is real, as the financial crisis proved.   

Cleaner services - Today, value added services, such as mobile banking, are tied to credit risk - if you want a bank's value added services, you have to take their credit risk. This will be fixed as these value added services become de-linked from deposit taking.     

Better terms - If self custody is an option, credit will be repriced on market-based terms.  

Less entanglement - Banks lend to each other, creating a potential domino effect in a crisis.  This problem will be reduced with self-custody as more money will be held outside of this interdependent system.  

Easier oversight - Self custody means fewer bad banks. Banks will need to compete to add value without monopoly protection. 

Consumer protection - Bank scams to create fake accounts, inflate overdraft fees and the like will be reduced because people will not be as dependent on banks.

With bitcoin, we can now rebuild the financial system on a firmer base.      

By Shane Hadden, CBP, CFA; shane@globalcurrencyreport.com

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