[andrewla]

I don't know what it means to say that it can't be used legally in fractional-reserve banking.

Fractional-reserve banking is just a pooled-risk lending instrument. If you can lend something, then you can fractionally reserve bank with it.

To put it another way, when you have dollars deposited in a bank, you exchange your dollars for a contract saying that the bank will remit so many dollars to you on demand. You value that contract at pretty much the face value of the dollar amount of the deposit because the risk of default on that contract is considered extremely low.

Fractional reserve banking in Bitcoin would work the same way -- the bank would give out loans while promising to make their depositors (creditors) whole should they require their deposits. They cannot satisfy that contract if more than a certain number of depositors come knocking, but that's true for regular banks too.

With a liquid credit market, even runs on the bank, as long as they are slow, are fairly tractable; you can just sell your debts for their face value (discounted, most likely, for the fact that the counterparty to the sale may not use the same risk metrics) and thereby make your depositors whole without having to call in any outstanding loans.