Various members of our community and other communities have at times spoken about reserves and fractional reserve in relation to our network. Some seem to think that 100% reserves are desirable and equate to solvency, while others (including myself) wish to avoid the use of reserves altogether to avoid counterparty risk. Some view reserves as the backing for NuBits, while others see NuShares as the only possible backing for NuBits:
Benjamin contends that reserves cannot be reliably used to back NuBits. I agree. This view implies that solvency and fractional reserve cannot be assessed by the size of any reserve. If there is no reserve, the notion of “fractional reserve” doesn’t even make sense in the context of our network. However, a related concept is the ratio of assets to liabilities as Benjamin pointed out, where NuShares are network assets and currencies issued are liabilities. If the NuShare market cap is 8 million NBT and there are 1 million NBT in circulation, the asset to liability ratio is 8, not counting any reserves that exist. This is a highly solvent state that doesn’t resemble anything like fractional reserve.
It is clear the original design of Nu as articulated in my whitepaper is a network that avoids the use of reserves entirely to eliminate counterparty risk. When a LPC provides their own funding for liquidity operations, they are implementing this zero reserve model. Shortly before our September release it became clear that NuBot would need to support primarily NBT/crypto pairs instead of just NBT/USD. This was difficult to implement quickly, which means it had some bugs initially and this approach introduces some extra risks which were not well understood and could not be accurately measured at the time. As a result, KTm and Jamie began using shareholder funds to provide liquidity, which may be regarded as reserves in some contexts. It is has been my intention all along that this would be a temporary situation as we would transition back to the original design of LPCs providing their own funds consistent with the zero reserve and zero counterparty risk model. Indeed all custodians besides Jamie and KTm are providing their funds and the transition is well underway.