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Bitcoin has a central bank called the “Bitcoin network,” which we will refer to as the Bitcoin Central Bank (BCB). Under this regulatory regime, money is not destroyed when bank debts are repaid, so increased money hoarding does not cause liquidity traps, instead it increases real interest rates and lowers consumer prices. The expected return of holding bitcoins is completely tied to its expected future exchange rate because bitcoins are currently a pure vehicle currency. The BCB does not intervene to stabilize these intermittent hype-cycles because steady appreciation of the exchange rate would allow for an even greater buildup of speculative excesses and the BCB would lose the confidence that AMST gives to long-term holders of bitcoins. This deep competitive advantage gives economic agents the expectation that it will be adopted as a method of payment and that its exchange rate liquidity will increase. However, the vast majority of bitcoin holders expect exchange rate appreciation at rates far greater than any borrower is willing to pay. The exchange rate volatility is a byproduct of the BCB choosing independent monetary policy (AMST) and free capital flow over a fixed exchange rate within the Impossible Trinity.
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This expectation has repeatedly proven to be true so the desire to hold bitcoins has increased, as indicated by the exchange rate and Internet search volume. This central bank issues a currency called “bitcoins” and processes the transfer of bitcoins between accounts. The Bitcoin Central Bank will be the longest lasting institution of its kind thanks to the anti-fragile independent monetary policy it has set in stone. The BCB’s rule-based monetary policy was set at its creation and its independence is secured by the distributed nature of the underlying network. The BCB issues bitcoins to a network of sub-contractors called “miners” who perform the proof-of-work calculations that secure the BCB’s independence and process payments. In case of investors who already hold Bitcoins, there is no need to panic as even in the case of any regulatory ban, it is likely that transitional provisions for sale would be made. The BCB does not need to take action to break the current equilibrium state since the hoarders’ expectations will be met given Bitcoin’s proven superiority to legacy payment networks and stores of value.
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It is debatable whether Bitcoin is a currency at all and why any country would want to replace it with their existing currency as Bitcoin does not have any intrinsic value of its own. Either way, these waves of adopters have a destabilizing effect on the exchange rate: speculators are unsure of the amplitude or wavelength of adoption, and amateurish punters let their excitement as well as subsequent fear overwhelm them. 1. Rational economic agents hold a balance of bitcoins even if they have no bitcoin-denominated liabilities. Economic agents overcome their cognitive biases to acquire bitcoins in waves due to the word-of-mouth marketing of the currency. For a deeper understanding of the market process involved in becoming global currency I would recommend reading Konrad Graf’s explanation of hyper-monetization and Peter Šurda’s liquidity analysis of bitcoins. The positive properties of AMST and PoWS combined make it certain that, absent a technological problem, Bitcoin will be adopted as the global currency. The BCB can offer lower transaction costs than any competitor by orders of magnitude because of the PoWS subsidy.
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Since the inception of Bitcoin in 2009, each and every transaction that has occurred is stored in a ledger, which is considered immutable, non-tamperable and irreversible. This is impossible with Bitcoin. 3. Fractional reserve banking cannot develop, so liquidity traps are impossible. Fractional reserve banking entails the creation of new money that is fungible with already preexisting money, i.e. it can be used interchangeably within the currency’s payment systems. This is the digital equivalent of the Chicago Plan or the Austrian 100% reserve gold standard. The following post provides an analytical framework so that critics and proponents of Bitcoin’s monetary policy can engage in a constructive debate. Once, the Finance Bill is ratified into an Act, the said framework would be made effective for Financial Year 2022-2023 onwards. The heterogeneous expectations of bitcoin holders regarding the exchange rate has led to the development of marginal lending operations. The taxation as per the Budget 2022 proposal would be taxation of gains at the rate 30% on transfer of Bitcoin. While there is a lot of uncertainty and volatility over the prices of Bitcoin and its legality in India, it is certain that the blockchain technology promises a whole lot of innovation and way in which transactions are settled.
