Bank Run, Fallacy of Composition
By: Team Remiit
Tags: Cryptocurrency, Blockchain, Cryptocurrency News, Cryptocurrency Investment, Token Economy

[CFO Jay Jung of REMIIT] One of the world leading economists in a field of economics, John Maynard Keynes is known as a writer of ‘General Theory of Employment, Interest, and Money,’ which is credited for the movement of Macro Stabilization Policy. He is also known as the author of ‘Fallacy of Composition,’ which explains the process of problems in the macroeconomy. The fallacy of Composition is a phenomenon that, in the economy, the individual’s reasonable decisions could cause irrational consequences as a whole, even though the individual inferred true part of the whole in the decision-making process. In economics, these reasonings often lead to unprecedented consequences. For example, when an economic depression is under prediction, an individual’s rational behavior could be a reduction in consumption and increase in savings so that he or she can prepare for future instability. However, these individual’s rational behaviors could accelerate economic recession decreasing effective demand in an overall financial system.

Bank Run is one of the extreme examples of Fallacy of Composition in banking. In 1983, Diamond and Dybvig theorized Bank Run explaining that it is one of the reasons causing an economic recession. The brief mechanism is as follows. Bank holds a portion of the savings and lends the rest. Not only banks but also other financial institutions use a similar system. In this system, when there is a fear spreading among the market that people might not be able to get their savings back, people’s rational behavior would be dashing at the banks to get their money back from their savings. In the fractional reserve banking system, an individual’s return request is not a problem. However, when these demands collected as a whole, the bank’s liquidity crisis will rise, and early withdrawal of loans will be in action, leading financial crisis or even economic crisis. Thus, the collection of individual’s reasonable behaviors, early withdrawal triggered by financial crisis prediction, could cause a financial crisis.

Of course, now that South Korea and other countries have undergone several financial crises, they assure investors through compensating investors with a certain level of deposit even in financial crises with secured deposits, depositor protection law, and deposit insurance, preventing the spread of anxiety which will trigger financial crises caused by Fallacy of Composition. Thus, the Bank Run scenario can be avoided through government’s intervention offering a certain level of assurance to gain the market’s confidence in banks. It is a fundamentally a question of trust regarding Bank Run as Fallacy of Composition.

The problem is the fact that Bank Run exists in current cryptocurrency market. Now that the cryptocurrency and blockchain token is neither positive or negative in South Korea, an exchange is one of six business sectors that regulated by government restricting the exchange to register as a venture or as small business. Therefore cryptocurrency also has a risk of Bank Run. It can be worthless at any time according to government policy. Besides, cryptocurrency and blockchain token industry had it coming that they are also credible for making the market highly risky. As the cryptocurrency market was overheated last November, some people dramatically made money. In this trend, there have been many scams attracting investment funds and run away with the money. Ernst & Young (EY), one of the world’s top four accounting firm, pointed out this problem in their report last October.

Combination of the unpredictability of government policy, overheated market, speculating, and fraudulent projects have resulted in extremely unstable cryptocurrency and blockchain token market. As a result, investors in the cryptocurrency market have become some sort of scalper aiming at short-term arbitrage trading at a rapidly changing price according to small changes or issues in the market. We all know that this market is not desirable.

Of course, it is undeniable that the government looked cold upon cryptocurrency and blockchain market because they initially claim for decentralization and substitution of legal tender. However, once the bubble of cryptocurrency has broke, a significant number of blockchain token projects are aiming for functioning within a limited ecosystem and promoting coexistence with legal tender instead of attempting to replace statutory currencies with decentralized cryptocurrency. If then, it is better to aim for the market where investors can fund reliably under appropriate regulations of blockchain projects and investments rather than the current market situation where there is neither confirm nor deny. Moreover, if the market stabilizes somehow through these regulations, the uncertainties in the market will be resolved, and the flooded small and medium-sized exchanges and unreliable projects can be cleaned up, i.e., improving the whole market condition.

Clearly, the cryptocurrency and blockchain token market is problematic. Although, this market has already grown too large to apply thorough regulations on these problems. Alternatively, it would be better for the entire economic system to induce a soft landing through a certain level of supervision.

Translated from Korean News, Edaily:

http://www.edaily.co.kr/news/read?newsId=01325126619435240&mediaCodeNo=257&OutLnkChk=Y