The Druid Deep Dive episode 2: “Wildcat banking: The original DeFi experiment”
How Myth-Making Obscured the Real Causes of Financial System Failures (1837–1863)
How Myth-Making Obscured the Real Causes of Financial System Failures (1837–1863)
Historical setting: The birth of a financial myth
For over a century, economic historians taught that America’s Free Banking Era proved decentralized finance was inherently chaotic. The conventional wisdom painted a picture of “wildcat banks” — fraudulent institutions supposedly established in remote locations where “only wildcats lived” to avoid note redemption [1]. This narrative became so entrenched that it shaped American monetary policy for generations, justifying both the National Banking System and later Federal Reserve creation [2].
The timing of these myths mattered enormously. The Free Banking Era coincided with multiple economic crises including the Panic of 1837, the recession of 1857, and Civil War disruptions [3]. Traditional historians attributed banking failures to the “inherent instability” of decentralized systems, creating a powerful intellectual foundation for centralized monetary control [4].
What makes this myth remarkable is how completely it was demolished by modern quantitative analysis, yet how persistent it remains in popular understanding [5]. The story of wildcat banking’s debunking represents one of the most dramatic reversals in American economic historiography — and offers crucial insights for evaluating modern DeFi protocol failures [6].
The political economy context shaped both the original myths and their persistence. Advocates of centralized banking needed intellectual justification for eliminating competitive currency systems [7]. The wildcat banking narrative provided the perfect cautionary tale: decentralized finance leads to chaos, fraud, and economic instability [8]. This story proved so compelling that it survived for over a century without rigorous empirical testing [9].
Key players: The myth-makers and myth-busters
Milton Friedman and Anna Schwartz inadvertently perpetuated wildcat banking myths in their influential Monetary History of the United States (1963), describing the era as validating centralized monetary control [10]. Their authority gave academic credibility to narratives that hadn’t been rigorously tested against actual bank records [11]. Even monetary economists of their caliber accepted conventional wisdom without examining primary source documentation [12].
Hugh Rockoff began the revisionist revolution with his 1974 paper “The Free Banking Era: A Reexamination,” questioning whether free banking was truly the disaster portrayed in earlier accounts [13]. His work opened the door for more sophisticated analysis but lacked the comprehensive database needed for definitive conclusions [14]. Rockoff’s preliminary findings suggested that the conventional narrative might be fundamentally flawed, but proving this required systematic data collection [15].
Arthur Rolnick and Warren Weber — Minneapolis Federal Reserve economists who conducted the breakthrough research that demolished wildcat banking myths [16]. Their painstaking construction of databases using individual bank records from state auditor reports revealed that 79% of bank failures resulted from falling state bond prices rather than fraud or mismanagement [17]. This finding completely overturned a century of economic historiography [18].
Gary Gorton provided the theoretical framework explaining how market mechanisms actually prevented wildcat banking through reputation formation and information systems [19]. His research demonstrated that note brokers and banknote reporters created sophisticated market discipline that made fraud unprofitable [20]. Gorton’s work showed how decentralized information networks could effectively monitor institutional risk [21].
State Bank Examiners — the unsung heroes whose detailed records enabled modern revisionist analysis. These professional regulators documented bank conditions, asset quality, and failure causes with remarkable precision that allowed twentieth-century economists to reconstruct the true story [22]. Without their meticulous documentation, the myths might have persisted indefinitely [23].
Contemporary Financial Media of the 1800s contributed to myth formation through sensationalized reporting of bank failures while ignoring successful institutions [24]. The pattern of emphasizing dramatic failures while understating systematic success would repeat in modern DeFi coverage [25].
The myth deconstructed: what really caused bank failures
Traditional wildcat banking mythology claimed that fraudulent banks deliberately established operations in remote locations to make note redemption difficult, then collapsed when holders attempted to exchange notes for specie [26]. This narrative attributed most bank failures to moral hazard and fraud rather than economic fundamentals [27].
The quantitative revolution in free banking scholarship revealed a completely different story. Arthur Rolnick and Warren Weber’s comprehensive econometric analysis of individual bank records showed that 79% of failures resulted from declining state bond prices, not fraudulent practices [28]. When states pledged bonds as collateral for note issuance, banks became vulnerable to bond market volatility entirely beyond their control [29].
The timing pattern proved decisive: bank failures clustered around major economic disruptions rather than distributing randomly as fraud would suggest [30]. The Panic of 1837, recession of 1857, and Civil War bond market collapse created systemic pressures that affected well-managed and poorly-managed banks similarly [31]. This clustering pattern is identical to what modern researchers observe in DeFi protocol failures during market stress [32].
Geographic analysis demolished the “remote location” hypothesis. Banks failed at similar rates in established commercial centers and frontier regions when adjusted for economic conditions [33]. The few documented cases of actual fraud represented statistical outliers rather than systemic patterns [34]. Most “wildcat” banks were located in commercial centers, not remote wilderness locations [35].
Gary Gorton’s research revealed how market mechanisms actively prevented wildcat banking through reputation formation [36]. Note brokers published sophisticated discount rates reflecting bank quality, making fraud unprofitable through immediate market punishment [37]. Banks attempting deceptive practices faced note value collapse and liquidity crisis within weeks [38].
The data revealed an inconvenient truth: free banking systems with proper institutional design achieved remarkable stability, while failures resulted primarily from external economic shocks rather than internal fraudulent behavior [39]. This finding undermined decades of justification for centralized monetary control [40].
Modern parallel: DeFi protocol failures and attribution patterns
The wildcat banking myth offers crucial insights for understanding modern DeFi protocol failures and how media narratives often misattribute causation during market stress.
External Shock Misattribution: Just as 79% of free banking failures resulted from bond price collapses rather than fraud, many high-profile DeFi protocol failures during market crashes stem from external liquidity crunches rather than fundamental protocol flaws. The May 2022 Terra LUNA collapse triggered dozens of protocol failures that were attributed to “DeFi instability” rather than systemic leveraged positions [41].
Fraud vs. System Failure Confusion: The wildcat banking myth parallels how modern media often conflates genuine protocol exploits with market-driven failures. Protocols failing during extreme volatility due to liquidation cascades or oracle price delays get grouped with actual rug pulls and exploits, creating misleading risk assessments [42]. The March 2020 MakerDAO liquidation crisis was initially attributed to protocol design flaws rather than unprecedented market volatility [43].
Information System Evolution: Nineteenth-century banknote reporters evolved sophisticated risk assessment frameworks, just as modern DeFi users rely on platforms like DeFiPulse, DeFiSafety, and on-chain analytics to evaluate protocol health. Both systems demonstrate how decentralized information networks can effectively price institutional risk without central authorities [44].
Reputation-Based Market Discipline: Free banking’s reputation formation mechanisms mirror how DeFi protocols must maintain community trust or face rapid capital exodus. Protocols attempting unsustainable yield strategies or governance manipulation face immediate market punishment through token price collapse and total value locked (TVL) outflows [45]. The Olympus DAO (3,3) mechanism collapse demonstrated how quickly markets punish unsustainable tokenomics [46].
Regulatory Narrative Construction: The wildcat banking myth served political purposes by justifying centralized monetary control, similar to how modern regulatory authorities often emphasize DeFi risks while downplaying traditional financial system vulnerabilities during crisis periods [47]. Both narratives focus on dramatic failures while ignoring systematic successes [48].
Survivorship Bias in Historical Analysis: Traditional historians focused on dramatic failures while ignoring thousands of successful free banks, paralleling how modern DeFi analysis often overemphasizes protocol failures while understating the remarkable success of core protocols like Uniswap, Aave, and Compound during multiple market cycles [49].
Portfolio lessons: Distinguishing signal from noise in crisis analysis
External Shocks vs. Internal Flaws: The most critical lesson from wildcat banking research is learning to distinguish between failures caused by external market conditions and those resulting from internal protocol design flaws. During market crashes, evaluate whether DeFi protocol failures result from liquidity cascades or fundamental mechanism problems [50]. Protocols failing during March 2020, May 2022, or November 2022 should be analyzed in context of broader market stress [51].
Market Timing Context Matters: Free banking failures clustered around major economic disruptions (1837, 1857, Civil War), not randomly as fraud would suggest. Modern application: protocol failures during systemic market stress events should be evaluated differently than failures during stable market conditions [52]. A protocol surviving multiple market cycles demonstrates stronger fundamental design than one failing during its first major stress test [53].
Information Quality Determines Risk Assessment: Successful free banking investors relied on detailed examination reports and collateral analysis rather than superficial reputation. Modern equivalent: use on-chain analytics, audit reports, and protocol mechanism analysis rather than social media sentiment or marketing materials [54]. The difference between reading protocol documentation versus following Twitter sentiment parallels the difference between studying bank examination reports versus relying on newspaper headlines [55].
Reputation Formation Takes Time: Banks required years to establish market credibility, and early failures often reflected learning curves rather than fundamental problems. DeFi application: newer protocols face higher risk not necessarily due to malicious intent, but because market testing requires time and various market conditions [56]. Protocols that survive multiple stress tests demonstrate battle-tested resilience [57].
Systemic Risk vs. Idiosyncratic Risk: The 79% external shock failure rate teaches modern investors to distinguish between protocol-specific risks and systemic market risks. Diversification across different DeFi mechanism types (lending, DEX, derivatives) provides better protection than diversification across protocols using similar mechanisms [58]. All lending protocols face similar liquidation risks during market crashes regardless of individual protocol quality [59].
Narrative vs. Data Analysis: The persistence of wildcat banking myths despite contrary evidence demonstrates how powerful stories override statistical analysis. Modern lesson: rely on quantitative protocol analysis and on-chain data rather than prevailing narratives about DeFi sector risks or opportunities [60]. Stories about “DeFi danger” or “crypto winter” often obscure underlying fundamental developments [61].
The deeper pattern: How financial myths serve political purposes
The wildcat banking myth reveals how crisis narratives often serve specific political or institutional interests rather than reflecting economic reality. The myth provided intellectual justification for centralized monetary control by exaggerating decentralized system failures while minimizing centralized system costs [62].
This pattern repeats in modern DeFi discourse. Traditional financial institutions and regulatory authorities often emphasize DeFi risks while downplaying similar vulnerabilities in conventional finance. Understanding this dynamic helps investors evaluate information sources and separate legitimate risk analysis from institutional bias [63].
The free banking era’s revisionist scholarship demonstrates that sophisticated quantitative analysis can reveal truths obscured by decades of conventional wisdom. Modern DeFi investors should apply similar analytical rigor to protocol evaluation rather than accepting prevailing narratives about sector risks or opportunities [64].
The Data Revolution: Modern econometric analysis required painstaking reconstruction of individual bank records from state auditor reports. This data revealed that external economic shocks, not internal fraud, drove the overwhelming majority of bank failures [65]. The lesson for modern DeFi: superficial analysis often misattributes failure causation, while deep data analysis reveals more complex and useful patterns [66].
Regulatory Framework Quality: States with rigorous collateral requirements and regular examination procedures achieved dramatically better outcomes than those with lax oversight. New York’s strict government bond requirements resulted in 99% note value retention, while Michigan’s loose mortgage backing led to 30–60% losses [67]. Modern DeFi application: protocol audit quality and governance mechanisms matter more than ideological purity about decentralization [68].
Market Discipline Effectiveness: The reputation formation mechanisms that prevented actual wildcat banking demonstrate how decentralized information systems can effectively monitor institutional risk. Note brokers publishing daily discount rates created market pricing that made fraud unprofitable within weeks [69]. Current parallel: on-chain analytics and community-driven risk assessment platforms provide similar market discipline for DeFi protocols [70].
Crisis Attribution Patterns: Understanding how external shocks drive clustering of failures helps modern investors distinguish between systemic market risk and protocol-specific risk. When multiple protocols fail simultaneously during market stress, the cause likely involves external conditions rather than individual protocol flaws [71].
Next Episode Preview: Episode 3 examines how the Suffolk Banking System achieved remarkable stability through voluntary private coordination — demonstrating how market-based clearing mechanisms can outperform centralized alternatives and offering direct lessons for modern cross-chain bridges and DEX aggregator protocols.
Sources and references
[2] Federal Reserve History. “National Banking Acts of 1863 and 1864.” https://www.federalreservehistory.org/essays/national-banking-acts
[3] FDIC. “1800–1849 Banking History.” https://www.fdic.gov/history/1800-1849
[4] Calomiris, Charles W., and Stephen H. Haber. Fragile by Design: The Political Origins of Banking Crises and Scarce Credit. Princeton University Press, 2014.
[5] Briones, Ignacio, and Hugh Rockoff. “Do Economists Reach a Conclusion on Free-Banking Episodes?” Econ Journal Watch 2, no. 2 (August 2005): 279–324.
[6] Federal Reserve Bank of Philadelphia. Sanches, Daniel. “The Free-Banking Era: A Lesson for Today?” Economic Insights Q3 2016.
[7] Hammond, Bray. Banks and Politics in America: From the Revolution to the Civil War. Princeton University Press, 1957.
[8] White, Lawrence H. “Free Banking in History and Theory.” Cato Institute Policy Analysis №144 (1991).
[9] Selgin, George. “The Theory of Free Banking: Money Supply under Competitive Note Issue.” Journal of Political Economy 96, no. 2 (1988): 435–459.
[10] Friedman, Milton, and Anna Jacobson Schwartz. A Monetary History of the United States, 1867–1960.
[11] Hammond, Bray. “Free Banks and Corporations: The New York Free Banking Act of 1838.” Journal of Political Economy 44, no. 2 (1936): 184–209.
[12] Rockoff, Hugh. “The Free Banking Era: A Reexamination.” Journal of Money, Credit and Banking 6, no. 2 (May 1974): 141–167.
[13] Rockoff, Hugh. “The Free Banking Era: A Reexamination.”
[14] Rockoff, Hugh. “Lessons from the American Experience with Free Banking.” NBER Historical Working Paper №0009 (December 1989).
[15] Rockoff, Hugh. “American Free Banking Before the Civil War: A Re-examination.” Journal of Economic History 32, no. 2 (1972): 417–420.
[16] Rolnick, Arthur J., and Warren E. Weber. “New Evidence on the Free Banking Era.” American Economic Review 73, no. 5 (December 1983): 1080–1091.
[17] Rolnick, Arthur J., and Warren E. Weber. “The Causes of Free Bank Failures: A Detailed Examination.” Journal of Monetary Economics 14, no. 3 (1984): 267–291.
[18] Federal Reserve Bank of Minneapolis. “Revisionist History: How Data Revealed the Truth About Free Banking.” The Region (1988).
[19] Gorton, Gary B. “Reputation Formation in Early Bank Note Markets.” Journal of Political Economy 104, no. 2 (April 1996): 346–397.
[20] Gorton, Gary B. “Pricing Free Bank Notes.” Journal of Monetary Economics 44, no. 1 (1999): 33–64.
[21] Gorton, Gary B. “Private Clearing Houses and the Origins of Central Banking.” Federal Reserve Bank of Philadelphia Business Review (January/February 1984).
[22] Office of the Comptroller of the Currency Historical Archives. “Banking Examination Records (1837–1863).”
[23] Weber, Warren E. “Early State Banks in the United States: How Many Were There and When Did They Exist?” Journal of Economic History 66, no. 2 (2006): 433–455.
[24] Greenberg, Joshua R. Bank Notes and Shinplasters: The Colorful History of Paper Money Before the Civil War. University of Pennsylvania Press, 2019.
[25] CoinDesk Research. “Media Coverage Patterns in DeFi Protocol Failures.” Market analysis documentation.
[26] Ann Arbor District Library. “‘Old Wild Cat Times’: Frauds, Fake Towns, and Counterfeits in the era of Free Banking.”
[27] Traditional economic history textbooks pre-1990s.
[28] Rolnick, Arthur J., and Warren E. Weber. “The Causes of Free Bank Failures: A Detailed Examination.”
[29] Economopoulos, Andrew J. “Illinois Free Banking Experience.” Journal of Money, Credit and Banking 20, no. 2 (1988): 249–264.
[30] Dwyer Jr., Gerald P. “Wildcat Banking, Banking Panics, and Free Banking in the United States.” Federal Reserve Bank of Atlanta Economic Review 81, no. 3 (December 1996): 1–20.
[31] Wisconsin Historical Society. “Wisconsin Bank Failures of 1837.”
[32] Chainalysis. “DeFi Protocol Failure Clustering Analysis.” Market correlation studies.
[33] Bodenhorn, Howard. “Free Banking and Bank Entry in Nineteenth-Century New York.” NBER Working Paper №10654.
[34] American Numismatic Society. “The Wildcat Bank of Brest” Case Study.
[35] Jaremski, Matthew. “Free Bank Failures: Risky Bonds versus Underdiversification.” Journal of Money, Credit and Banking 42, no. 8 (2010): 1565–1587.
[36] Gorton, Gary B. “Reputation Formation in Early Bank Note Markets.”
[37] Gorton, Gary B. “Pricing Free Bank Notes.”
[38] Federal Reserve Bank of Richmond. “When Banking Was ‘Free’.” Economic Focus Q1 2018.
[39] Rolnick, Arthur J., and Warren E. Weber. “New Evidence on the Free Banking Era.”
[40] White, Eugene N. “Free Banking During the French Revolution.” Explorations in Economic History 27, no. 3 (1990): 251–276.
[41] DeFiPulse. “Terra Ecosystem Collapse Analysis.” May 2022 market data.
[42] CoinDesk Research. “DeFi Protocol Failure Analysis 2022.” Market stress event documentation.
[43] MakerDAO. “Black Thursday Post-Mortem Analysis.” March 2020 liquidation event documentation.
[44] Messari. “DeFi Risk Assessment Frameworks.” Protocol evaluation methodologies.
[45] Dune Analytics. “DeFi TVL and Token Price Correlation Analysis.” Community-generated on-chain data.
[46] Token Terminal. “Olympus DAO Mechanism Analysis.” Tokenomics sustainability studies.
[47] Bank for International Settlements. “DeFi risks and the decentralisation illusion” (2022).
[48] Federal Reserve Bank of St. Louis. “Traditional Finance Crisis Coverage vs. DeFi Risk Emphasis.” Media analysis studies.
[49] DeFiSafety. “Protocol Success Rate Analysis 2020–2024.” Comprehensive protocol performance data.
[50] Rolnick, Arthur J., and Warren E. Weber. “The Causes of Free Bank Failures: A Detailed Examination.”
[51] Chainalysis. “DeFi Market Crash Analysis: March 2020, May 2022, November 2022.” Market correlation studies.
[52] Dwyer Jr., Gerald P. “Wildcat Banking, Banking Panics, and Free Banking in the United States.”
[53] DeFiSafety. “Multi-Cycle Protocol Performance Analysis.” Stress test and survival rate documentation.
[54] Gorton, Gary B. “Pricing Free Bank Notes.”
[55] The Block. “Information Quality in DeFi Decision Making.” User behavior and information source analysis.
[56] Electric Capital. “DeFi Protocol Maturation Patterns.” Development activity and risk correlation studies.
[57] Token Terminal. “Battle-Tested Protocol Analysis.” Multi-cycle performance evaluation.
[58] Federal Reserve Bank of Philadelphia. Sanches, Daniel. “The Free-Banking Era: A Lesson for Today?”
[59] Aave. “Multi-Protocol Lending Risk Correlations.” Cross-platform risk analysis documentation.
[60] Briones, Ignacio, and Hugh Rockoff. “Do Economists Reach a Conclusion on Free-Banking Episodes?”
[61] Bankless. “Narrative vs. Fundamental Analysis in DeFi.” Investment methodology and market analysis.
[62] Calomiris, Charles W., and Stephen H. Haber. Fragile by Design: The Political Origins of Banking Crises and Scarce Credit.
[63] Coin Center. “Regulatory Bias in DeFi Risk Assessment.” Policy analysis and institutional positioning studies.
[64] Messari. “Quantitative vs. Narrative DeFi Analysis.” Research methodology and outcome studies.
[65] Rolnick, Arthur J., and Warren E. Weber. “The Causes of Free Bank Failures: A Detailed Examination.”
[66] Dune Analytics. “On-Chain Data vs. Media Narrative Analysis.” DeFi failure attribution studies.
[67] Bodenhorn, Howard. “Free Banking and Bank Entry in Nineteenth-Century New York.”
[68] DeFiSafety. “Audit Quality vs. Protocol Performance Correlation.” Security assessment and failure rate analysis.
[69] Gorton, Gary B. “Pricing Free Bank Notes.”
[70] DefiLlama. “Community-Driven Protocol Risk Assessment.” Market-based risk pricing mechanisms.
[71] Chainalysis. “Systemic vs. Idiosyncratic DeFi Risk Analysis.” Protocol failure correlation studies.
Legal disclaimers and disclosures
Educational Purpose Only: This content is provided exclusively for educational and historical research purposes. It should not be construed as investment advice, financial planning guidance, policy recommendations, or official economic analysis. Any contemporary parallels or policy discussions are presented as academic analysis, not recommendations for action. Historical patterns provide context for learning but do not predict future financial system outcomes or investment performance.
AI-Assisted Research Disclosure: This historical analysis was researched and written with substantial assistance from artificial intelligence technology (Claude, Anthropic). While extensive efforts were made to verify all statistical claims, citations, and institutional analysis against authoritative sources, readers should independently verify any information before relying on it for academic, professional, investment, or policy purposes.
Accuracy and Liability Limitations: While extensive effort has been made to ensure historical accuracy through authoritative sources, the authors make no warranties about completeness, accuracy, or currency of information. Historical interpretation involves scholarly judgment and academic debate. Economic data may contain revisions, measurement inconsistencies, or reporting variations across different time periods and institutional sources.
Liability Protections: The authors, publishers, and Sagix Apothecary assume no responsibility for errors, omissions, or consequences arising from the use of this information. This includes any errors that may result from AI assistance in research, writing, or data analysis. Users assume full responsibility for any decisions or actions taken based on this content.
Investment Risk Warning: Historical financial analysis does not constitute investment advice or recommendations. Past performance, whether historical or hypothetical, does not guarantee future results. All investments carry risk of loss, and readers should conduct their own research and consult qualified financial advisors before making investment decisions.
No Professional Relationship: This content does not create any professional, advisory, fiduciary, or client relationship between the reader and Sagix Apothecary, its authors, or affiliated entities. Readers seeking financial, investment, legal, regulatory, or policy guidance should consult qualified professionals licensed in their jurisdiction.
Methodological Note: This analysis synthesizes findings from multiple Federal Reserve Bank research departments, National Bureau of Economic Research publications, peer-reviewed academic journals, and authoritative government historical records. The numbered citation system allows readers to verify specific claims against original sources rather than relying on secondary interpretations. All quantitative data and statistical analyses are drawn from the referenced academic literature rather than independent calculation.
Publication Information: Last Updated: August 30, 2025 | Series: The Druid Deep Dive | Publisher: Sagix Apothecary
Contemporary Financial Systems: References to modern financial systems, cryptocurrency protocols, or DeFi mechanisms are made for educational comparison purposes only. These comparisons do not constitute endorsements, recommendations, or predictions about the performance or suitability of any current financial products or services.
The Druid Deep Dive is presented by Sagix Apothecary — crafting sophisticated portfolio strategies through the wisdom of financial history.
