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How Bitcoin Affects Monetary Policy

Published: 20th August 2021 18:39

 

Bitcoin’s dominance and continued market growth have prompted many people and institutions to wonder how it may affect the conventional monetary policy. Some people worry that this virtual currency could undermine the central banks’ ability to manage economic policy objectives at the national level. At the same time, some people argue that central banks could benefit from issuing national cryptocurrencies.

Bitcoin and the Threat to Monetary Policy

Some people argue that Bitcoin and the traditional monetary system can co-exist, whether people purchase units as alternative investments or their potential technological applications. However, some feat that wide Bitcoin adoption could generate a spillover effect or negative externality on the entire economy by creating monetary instability.

It’s worth noting that virtual currencies currently comprise a minuscule fraction of financial assets globally. Bitcoin’s market capitalization is about $100 billion, around 1.3% of the total 7.6 trillion in global banknotes and coins.

Maybe this might change at some point, affecting the options for central bankers. However, global monetary managers can relax because Bitcoin’s existence will hardly hinder their daily operations. Though virtual currencies might not raise significant concerns at the moment, they can cause financial stability problems upon achieving wide-scale usage.

Some experts argue that Bitcoin could serve as an alternative asset during economic adversity, thereby frustrating addressing credit and price risks due to unstable US dollar exchange rates. However, this argument can apply to other things that can serve as attractive alternatives to the US dollar during financial crises. And up to now, no policymaker has suggested a limit to their exchange rates.

Should Countries Issue their Virtual Currencies?

Not every central bank or country is immediately antagonistic towards Bitcoin and other virtual currencies. Countries have diverse opinions, with some central banks commissioning research and creating exploratory committees for determining how they can leverage these new technologies.

The high number of individuals using platforms like Yuan Pay Group, check this link to purchase and sell this digital currency. People are also using Bitcoin to pay for services and goods locally and online. All these activities suggest that Bitcoin can function like cash. Thus, it can serve as a semi-anonymous exchange medium that people access globally without relying on banks. And Bitcoin’s digital nature is attractive because it makes it easier to manage and cheaper than the conventional financial system.

For this reason, some central banks are considering launching their virtual currencies. Countries like China have already developed a Central Bank-issued digital currency. In El Salvador, discussions to make Bitcoin a legal tender are underway. In Sweden, Riksbank is pursuing a cryptocurrency too.

All these are laudable movements, but officials should remember that digital currencies may not meet the central banks’ requirements for monetary bases. Ideally, no single party can control financial supply in the public ledger or blockchain. And this explains why governments have difficulties regulating Bitcoin. Ideally, the central bank tightens or loosens the money supply depending on a country’s economic conditions. However, Bitcoin and other blockchain-based virtual currencies can’t fit this criterion. Satoshi Nakamoto created Bitcoin to be free of government or central bank’s manipulation.

The Bottom Line

Some central banks are worried that Bitcoin could negatively affect their monetary policies by reducing their conventional currency usage. For this reason, some central banks have embarked on research and other activities to produce their virtual currencies to compete with Bitcoin. However, this may not solve the problem because blockchain-based virtual currencies use a distributed network that frees them from regulation or manipulation by any entity, including central banks. Nevertheless, digital currencies like Bitcoin will expand monetary options for all people while enhancing transaction security.

 

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