CRYPTOCryptocurrency Crashes Recall the Wild Days of “Free Banking”

By Sara Harrison

Chenzi Xu feels like she’s watching history repeat itself. The cryptocurrency exchange FTX recently went belly up, vaporizing billions in customers’ deposits. A few months earlier, the Luna coin lost 99% of its value in one week, the latest in a series of shocks to the crypto market that started when Bitcoin’s value plunged in early 2022. These crashes, Xu says, recall the wild days of the mid-19th-century American banking system, when thousands of banks printed their own currencies, often backed by unreliable investments.

“There’s a time historically when we didn’t have fully backed banknotes,” says Xu, an assistant professor of finance at Stanford Graduate School of Business. “So we had lots of runs on those notes and, subsequently, bank failures.” Xu sees many of the mistakes and vulnerabilities of that era being played out today in the largely unregulated market for digital money.

In a new working paper for the National Bureau of Economic Research, Xu and He Yangopen in new window, a former graduate student in economics at Harvard, look at what banking in the U.S. was like on the eve of America’s first modern banking regulations. “It’s absolutely wild,” Xu says. “The U.S. was very anti-centralization, especially in the financial sector.”

In 1836, President Andrew Jackson let the charter of the Second Bank of the United States expire, kicking off what is now known as the Free Banking Era. The country had no unified banking system. Instead, towns had their own independent banks, all of which were only allowed to have one branch. On the eve of the Civil War, there were 1,600 private banks across the country and, confusingly, each one used a different kind of money, known by names like shinplasters, shingles, stump tails, and red dogs. “Every bank would fund itself in part by printing paper money, and therefore every single individual bank around the U.S. would have its own currency,” Xu says.