Crypto banks owe each other money

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Intuitively, the operation of an unregulated bank looks like this. You — the shareholder and CEO — start a bank and put in $10 of your own money as seed capital. The bank has $10 in equity, accepts $100 in deposits, and grants $110 in loans. If the loans are repaid with interest, the bank ends up with, say, $116, it pays its depositors $103 (with interest), and you get your $10 back with $3 in profit. If $20 of the loans are in default, the bank only has $90 (plus interest, say, $94); depositors get 94 cents back on the dollar and you lose everything.

But all of this happens over time. The bank borrows short term to lend long term: depositors can ask for their money at any time, but most of the time most of them don’t, so the bank can make long-term loans term that pay higher interest. One thing this means is that if all the bank’s loans are perfectly good, but all the depositors ask for their money at the same time, the bank won’t get it; it will have to sell its loans at discounted prices to raise money, and depositors will end up getting back less than they invested. The “run on the bank” will itself cause depositors (and shareholders) to lose money.

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