Bitcoin Monetary Policy

#blockchain #bitcoin #cryptocurrency #inflation #monetary

Anshita Khurana Feb 09 2021 · 3 min read
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Among the many printed currencies that exist in the world, there also exist virtual currencies called cryptocurrencies. These cannot be seen or touched but are still being used for trading amenities. In electronic payment systems, cryptocurrencies are digital money that does not necessarily require government backing or the intervention of an intermediary, such as a bank. Instead, using certain protocols, participants of the system verify payments. In comparison to the centralized digital money and central banking systems, cryptocurrencies usually use decentralized control. Each cryptocurrency functions through distributed ledger technology, usually a blockchain when applied with shared power, which serves as a record of public financial transactions. One such cryptocurrency is Bitcoin.

Blockchain Mining

Bitcoin (₿) was invented by an anonymous person or group of individuals using the name Satoshi Nakamoto in 2008. In 2009, when its implementation was published as open-source software, the currency started to be used. Bitcoin then proceeded to generate a mechanism for electronic transactions as a peer-to-peer network. The use and popularity of bitcoin have grown rapidly, and it is a prominent digital currency system. Other cryptocurrencies have been developed since bitcoin was published.

The authenticity of the coins of each cryptocurrency is provided by a blockchain. Blockchain is a technology. It is a database, a chain of blocks that are linked together using cryptography. Each block includes a hash pointer as a link to a previous block, a timestamp, and transaction data. Blockchains are, by nature, intrinsically resistant to data alteration Once registered, without the modification of all subsequent blocks, the data in any given block cannot be retroactively changed.

Bitcoin as a Reward

In blockchain networks, mining is a validation of transactions. For this effort, successful miners obtain new bitcoins as a reward. Since bitcoin is a decentralized currency, there is no authority that brings bitcoins into the market. Bitcoins are available in the market only by mining them.

Bitcoins are mined using distributed network computational power. Transactions made with Bitcoin are also processed by this network. Since Bitcoins are mined on a computational power basis, it takes time to generate them. To hold it valuable, it has been reported that miners can only produce 21 million bitcoins. All Bitcoins will be generated by the year 2140. Thousands of machines with extremely high processing capacity across the globe process transactions and protect the network by solving complicated mathematical equations and receiving fresh bitcoins in return.

Bitcoin Monetary Policy:

The monetary policy consists of two major components:

  •  The Halving:
  • Every 4 years, the number of Bitcoins issued into the system is halved. The halving actually takes place after every 210000 blocks, which takes about 4 years to produce (one block is added to the blockchain every 10 minutes).

    When bitcoin started in 2009, the block reward on successful mining of one block was 50 Bitcoin every 10 minutes. In November 2012, Bitcoin’s 1st Halving took place and the block reward reduced to half i.e., 25 Bitcoin from 50 Bitcoin. In July 2016 Bitcoin’s 2nd halving took place (reward reduces to 12.5 Bitcoin) and the next halving which is Bitcoin’s 3rd halving took place in May 2020 (reward reduced to 6.25 Bitcoin).

    It also means that mining can get more complex over time. As network complexity rises with time and the payout rate decreases, each Bitcoin increases the real cost of mining, which will then also raise the market value of each Bitcoin. The reduced supply would also lead to a rise in Bitcoin prices as their scarcity also rises proportionately. Right now, there is almost 18 million Bitcoin (85% of total supply) in circulation.

    Process of Halving
  • Block Frequency:
  • Block frequency is described as how much the blocks join & split the incentive for Bitcoin, which is now 6.25 Bitcoin per block. For numerous cryptocurrencies, the Average Block-Time or Block Frequency is different. For example, for Bitcoin, the average block time is 10 minutes. For Ethereum, that's around 15 seconds. It is 3.5 seconds for Ripple.

    Bitcoin vs Inflation

    Bitcoin has a set limit of 21 million coins that can be generated. This restricted supply allows inflation to be controlled by bitcoin. There's no central bank continuously distributing currency and regulating monetary policy in the case of Bitcoin. There's an algorithm instead, which runs out until it reaches 21 million coins. After that, any BTC that is missing is permanently withdrawn from the supply of capital, ensuring that with time, the overall supply will decline or deflate.

    Bitcoin Monetary Inflation-

    Bitcoin monetary base will not be extended, even if it were commonly adopted, the currency will be subject to extreme deflation. Bitcoins lack three essential functions expected to be performed by stable monetary regimes:

  • Defense against the possibility of depreciation of systems
  • The ability to flexibly respond to transient shocks to the need for capital and thus smooth the market cycle
  • The ability to act as a last-resort lender.
  • In conclusion, Bitcoin is the next big thing and it will become increasingly rare and increasingly valuable over time.

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