How would a bitcoin standard fare for a monetary system? An analysis by the Bank of Canada examined that scenario, conjecturing how a bitcoin standard would perform based on the performance of a gold standard that existed from 1880 to 1913. The gold standard was a monetary system in which nations’ currencies were tied to gold.
The 37-page paper [PDF] is written by Warren E. Weber, research consultant at the Bank of Canada, visiting scholar for the Federal Reserve Bank of Atlanta, and adjunct professor at the University of South Carolina.
The paper claims that because there would be no arbitrage costs for global transactions under a bitcoin standard, nations would not be able to follow independent interest rate policies. Central banks would retain limited ability to serve as last-resort lenders.
A bitcoin standard would have two key benefits over fiat currency. One is there would be more price level predictability on account of the deterministic rate by which the cryptocurrency is created. A second is that resources devoted to hedging against exchange rate fluctuations would be free to use in more productive ways.
Based on the classic gold standard period from 1880 to 1913, the paper claims currency under a bitcoin standard would have mild deflation and constant exchange rates.
Countries adopted the gold standard to achieve exchange rate stability against those of other countries that also adopted the standard. Stability was achieved through gold arbitrage. But because gold arbitrage incurred costs, exchange rates between different countries’ fiduciary currencies were not fixed but were limited to a range around their par values.
The bitcoin standard would be similar to the gold standard in that it would not be under the control of a monetary authority or a central bank.
The changes in the bitcoin supply would be determined by the algorithm governing the number of new bitcoins miners receive for verifying transactions and adding them to the bitcoin blockchain.
Change in the global gold stock was similarly based on gold discoveries and the invention of new ways to extract gold from ores.
As three distinct exchange media existed under the gold standard, three exchange media would exist under the bitcoin standard. They are: fiduciary currencies issued by central banks, bitcoin, and fiduciary currencies (deposits or bank notes) commercial banks issue.
Under the cryptocurrency, the scope of monetary policy would be more limited than under a gold standard. The capability of issuing fiduciary currency would provide central banks limited ability to serve as last-resort lenders. However, the costless arbitrage of the cryptocurrency would prevent central banks from implementing interest rate policies to impact nations’ economies.
The experiences of the gold standard yields the following conjectures about the performance of a bitcoin standard:
1) Long-term, deflation would be moderate and would grow over time until a deflation rate equal to the negative of the rate of growth of global output around 2016.
2) Price levels of countries would be highly, though not perfectly, correlated, similar to how they were under the gold standard.
3) The exchange rates among fiduciary currencies of countries would remain fixed at par since the cost of bitcoin arbitrage is essentially zero.
4) Financial crises would still occur since they can happen under any fractional reserve financial system.
The paper also postulates how long the bitcoin standard would last if it came into existence.
A bitcoin standard could come into existence if the cryptocurrency became the predominant medium of exchange or the backing for the predominant medium of exchange. The paper offers different scenarios of how this might happen, but it notes this is not likely to happen. The author also states he is not advocating a bitcoin standard.
But even if the bitcoin standard came into existence, it would not last long, the paper argues. The payments industry is changing so fast that technological innovation would provide a medium of exchange with benefits similar to or better than the cryptocurrency. Such an innovation would come from either the government or the private sector.
Another factor contributing to the short existence of the bitcoin standard is that pressure would exist to return to a fiat money system so a more active monetary policy could be pursued.
The author does not think it likely a bitcoin standard would emerge since central banks and governments would oppose it. These parties want to protect the seigniorage revenues from creating money. They also want to retain the ability to deploy interest policies to affect domestic economies.
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Last modified: March 4, 2021 4:47 PM