The Layman’s Guide to Bitcoin and the Blockchain.

Background: Centralized Institutions

Banks

You may have heard about the 2008 financial crisis. What you probably don’t know is that the global financial impact was magnified by excessive risk taking by banks.

Banks, legally, were only required to actually hold 10% of your money in liquid assets. A liquid asset is anything that can be transferred easily: cash and stocks? Sure. But a house? Not exactly.

So every time you put in 10 million dollars in to the bank, they’d only have 1 million out of the 10 you gave them in cash. The other 9 they’d use for investing and other purposes?—?they’d put it in assets that would grow in value over time. The reason they’re able to give you back 5 million when you ask for it is because there’s some other guy who’s put 100 million in the bank, so the bank has that 10 million from that guy’s money to take from to give to you. At the point where they have less than 10% total, they’re required to liquidate (read: move to cash) enough of their assets to abide by the 10% rule. (Note: the legal requirement is that the bank must keep 10% of their total deposited assets,among all their customers).

On a side note, if you’ve ever wondered why, this explains the reason why banks offer different types of bank accounts: checking accounts generally require high liquidity (because you need to withdraw frequently), so banks can’t take much and use it for investing; they need to keep it in cash. Savings accounts are for long term, so banks can use it for investing and to grow that money. It makes sense that banks want to incentivize customers to use these accounts more so that banks can invest more of this money?—?they do that in the form of higher interest rates for savings accounts and close-to-zero rates for checking accounts.

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So what happens when a lot of people want to pull their money out of the bank at once? Well, the bank can give the 10% they have, but often times, the other 90% isn’t very liquid and the bank has to say “Sorry, but we lost $90 million of your deposits. Here’s 10 million though, have a nice day!”

And then you have the Great Depression.

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