Virtual assets and fractional banking

Before there was any clearer regulation of virtual assets (e.g., crypto), statements from various regulators or draft laws, it was initially obvious that the new actors did not want to be, let’s say, traditional.

From the start they viewed leverage with great suspicion. But not only that. The structure, in general, was being shaped around having 100% backing of what was collected, and they also did not want to borrow against it. In other words, funds were raised from third parties, everything collected was fully backed, and, on top of that, a capital reserve or guarantee had to be maintained (this was later added by regulation, in any case).

The virtual-asset market, therefore, was intended to be built from legal intermediation, not financial intermediation. Some of this rebelliousness is a reaction to what happened in 2008.

We had institutions that custody virtual assets; they did it for you, charged a fee, and could not use your assets while you were not using them. If they custody, transact, route, or intermediate, they cannot use them.

By contrast, the traditional logic involves taking in deposits, then placing them elsewhere, putting that capital to work, and finally paying something in return. Banks do this via deposits; a broker might call you to lend your assets to another investor; or another market agent might ask you to sign rules or contracts to make use of a fund’s or portfolio’s assets.

We know well, especially from the FTX case, that this did not succeed or would not succeed. But we want to say something simpler. The initial logic was never the traditional one, but rather buy, hold, and return. At least that is the impression.

It was a hard‑money logic. They might eventually become fiduciaries, but they did not want fiduciary “money.” They could not be inflated or manipulated by the state. It is more like gold, because of its apparent scarcity. This was therefore consistent with full‑reserve banking, as opposed to fractional banking.

Today banks, and to some extent other agents, are allowed to use third‑party assets. The idea behind it is to promise everyone what they want to hear. People want to leave their money and be able to get it back at any time (to attract deposits). People want to buy a house and pay it off over a very long term (to place funds). The problem is when these get out of sync, but this fractional system is driven by human nature.

The point is that this is already happening with virtual assets worldwide. It is enough to recall 2022 and the start of the “Crypto Winter.” And it can be problematic.

A first problem could be, however, what virtual assets are used for in placement. When we look at the regulation, it is not very clear that the placement of virtual assets serves to finance—at the root of all this, channeling savings to good ideas—activities outside the market. But let’s be careful. We do not mean that it is wrong to finance market transactions or operations with virtual assets, since that is already a significant activity in itself. Rather, we mean that they do not finance other markets (the purchase of a house, a company’s bridge loan, etc.).

What is interesting is that, at least in our experience, we have never seen a virtual‑asset operation that finances long‑term projects. Beyond some collateral in virtual assets, operations are generally financed on a short‑term basis. The legal question, we believe, is more about the riskiness of these operations—market operations tend to be riskier than real‑economy activities—and whether they truly provide a guarantee if something goes wrong. And with that, whether the regulation will actually work.

A second problem could be how to regulate something like what happened in 2022. A good example is Chile. When we look at part of the regulation of virtual assets, the Fintec Law (Law No. 21.521), we do not see regulation like the General Banking Law, but rather one more like the Securities Market Law. The Fintec Law is, as we say here, a miniature securities market, with brokers (intermediaries), exchanges (platforms or alternative trading systems), and custodians. Part of the infrastructure (routing and advisers) is separated out, but it is clearly very similar.

The point is that the problems caused by virtual assets resemble much more closely the banking problems we have been discussing than the typical securities issues (for example, “my broker used the asset without permission”). Securities regulation seeks to provide full information because investors need to make good decisions. Banking regulation, by contrast, assumes that depositors should not have frictionless access to all information—not like the app‑level access to the crypto market—because if problems arise, a bank run (now via mobile) is part of a bank’s nature and very hard to prevent. The regulator is responsible for information (asset quality, liquidity, reserve requirements, capital ratios, etc.). The idea is that the depositor should be insensitive to that information.

With virtual assets, nothing appears to be insensitive to information, especially on gamified platforms.

We should be very alert if the virtual‑asset market begins to recreate banking, because that would demand, you know, banking regulation (financial intermediation). That is quite onerous, because of deposit insurance and the central bank’s lender‑of‑last‑resort function. And, moreover, it largely sidelines freedom of contract by forcing the regulator to require agents to invest their capital in certain assets.

A third problem could be the creation of a wall between the traditional world on one side and the world of virtual assets on the other. They would make us choose, being completely separated (without prejudice to Open Finance).

A fourth issue to keep in mind is that current virtual‑asset regulation does not, with the delicacy of banking law, distinguish who deposits what and who benefits from the placement. In banking law, the statute does consider whether, say, a deposit is demand or term; whether it is an interbank loan; or whether the same person to whom we are lending (credit limit) has already borrowed too much from an institution. In the field of virtual assets it can be indifferent whether the depositor and the debtor are institutional or not, and concentration i