What is the monetary policy of crypto?
Monetary policy in crypto involves mechanisms which are used to manage the circulation and supply. These structures are designed to ensure the sustainability, stability and predictability of a coin’s worth over time.
Rather than relying on central banks and governments, as with regular fiat currencies, cryptocurrencies are managed by decentralized protocols for their monetary policies. These protocols may have several tools to regulate the supply of the cryptocurrency, including block rewards, modifications to the mining difficulty, and issuance rates.
For example, Bitcoin (BTC) has an upper limit of 21 million coins. As time passes, the rate of new coins being added to the supply decreases. This will eventually lead to a deflationary environment as the rate of new supply approaches zero.
Contrary to popular belief, some cryptocurrencies might employ other mechanisms to control their monetary policies, such as the proof-of-stake consensus systems (PoS), which use staking to drive network activity and regulate the cryptocurrency supply.
How are cryptocurrencies given monetary value?
Cryptocurrencies have monetary value because people give them value, just like any other asset or currency.
A cryptocurrency’s cost is mainly determined by market forces of supply and demand. If there are more buyers than sellers willing to accept the cryptocurrency, it will be more expensive. However, the price of cryptocurrency will drop if there is more supple than buyers.
Related: Tokenomics: A beginner’s guide to the supply and demand of cryptocurrencies
There are three main factors that could influence the cost of cryptocurrency: its utility, security, adoption, and popularity. A cryptocurrency that is widely accepted as a payment method and has obvious uses will likely be more valuable than one that isn’t. Additionally, cryptocurrencies with strong security features and a history of reliability are usually more valuable than those that have weak security or a record of hacks and flaws.
How will cryptocurrencies affect monetary policy?
The exact influence of cryptocurrency will depend on how widely they are used and how integrated they are into the existing financial system. Cryptocurrencies have the potential to influence monetary policies in many ways.
Here are a few of the possible ways that cryptocurrencies could affect monetary policy.
- Less control over money supply: Cryptocurrencies are decentralized and don’t have a central controlling entity, which means standard monetary policy tools like printing money or changing interest rates may not have the same impact on them as on fiat currencies. This might limit central banks’ abilities to influence the total amount of fiat money in circulation.
- Fresh sources of data: Large amounts of transactional data generated through cryptocurrency can be used to gain meaningful insights into consumer behaviour and wider economic trends. Central banks will need to figure out how to incorporate these data into their decision-making.
- Increased competition: Cryptocurrencies offer an alternative payment method and store of value, making them more competitive than regular fiat currencies. This can make it difficult for central banks to keep their currencies stable and valued in order to remain competitive. Additionally, banks are exploring CBDC projects as a response to the potential threat of cryptocurrencies, which could disrupt traditional banking and payment services.
- Improved financial inclusion: Cryptocurrencies have the capacity to enable people and businesses to have better financial access and inclusion. Therefore, central banks will need to consider how a more varied and decentralized financial system might behave.
Related: What is a CBDC? Why Central banks are interested in digital currencies
Who controls Bitcoin’s monetary policy?
The monetary policy of BTC is controlled by the rules written into the Bitcoin Software protocol, which is open-source and works in a decentralized way.
The protocol’s rules define how new BTC is created and distributed over time. Any proposed changes to the protocol must be approved by a majority of the network’s users, making Bitcoin’s monetary policy subject to the consensus of its users.
Particularly, the protocol’s built-in issuance schedule serves as the basis for Bitcoin’s monetary policy. This schedule defines the number of coins that will be created in a set period of time, as well as the rate at which these coins are distributed.
Cryptocurrency is a digital form of money, which uses cryptography to secure transactions and control the creation of new units. Bitcoin is the most widely used and well-known cryptocurrency, with a maximum supply of 21 million total units. This strict supply limit is managed by miners, who compete to solve mathematical puzzles in order to earn new Bitcoin (BTC) tokens. Every 210,000 blocks, or approximately every four years, the mining reward is halved. The result is a consistent supply of Bitcoin and a protection against inflation.
