Failed monetary policy positively affects Bitcoin market demand

In the beginning of 2009, the global financial crisis was in full effect. In the United States of America, massive government bailouts were taking place repeatedly. It is also at that time that Bitcoin, a peer to peer electronic cash system, was first introduced by Satoshi Nakamoto. The multiple failures of policy makers had in effect expedited the creation of Bitcoin, and the other cryptocurrencies that followed. We shall see how market demand for Bitcoin might be affected positively by failed monetary policy.

Monetary policy is a critical component of central banks’ responsibility. Usually, central banks like the Federal Reserve have a dual mandate: to target inflation and also unemployment. To direct monetary policy, central banks have a certain amount of tools at their disposal, namely, the reserve ratio, the key interest rate, and open market operations. Their aim is to reach monetary equilibrium, i.e. the quantity of money equals what the public demands at the current price level. Failed monetary policy will result in possibly two things: high inflation on the one hand, or deflation on the other hand.

Inflation of fiat currencies will mean that they will be even less suited to act as a store of value than they are today. Therefore, a safer long term investment will be Bitcoin and other digital currencies. This will consequently drive the demand for digital currencies. For example, failed monetary policy in Zimbabwe resulted in unprecedented levels of inflation, leading to its currency’s demise. Alternatives such as the South African Rand and the US dollar are being used in that country. The demand for bitcoin is also skyrocketing in Zimbabwe, with prices reaching up to $7,200 for 1 BTC. Venezuela is another example in a similar situation. Hyperinflation in that country has rendered cash useless. Consequently, the use of digital currencies is becoming quite common.

Deflation of fiat currencies on the other hand will mean that they will be less used as a medium of exchange, but more as a unit of account. In this case, cryptocurrencies such as Bitcoin can fulfill the role of medium of exchange, with the fiat currencies still remaining the unit of account. Subsequently, the market demand for Bitcoin will surge. Since the supply of bitcoins is predetermined and cannot be altered, this will inevitably lead to a rise of the price of bitcoins.

Globally, liquidity issues relating to fiat currencies which serve as global reserve currencies can also drive Bitcoin demand. Indeed, countries that issue global reserve currencies always face the Triffin Dilemma, which states that these issuing countries cannot maintain the value of the reserve currencies while providing liquidity to the world. For example, there may not be enough US dollars available for the global market as the Fed is trying to minimize inflation domestically. In this case, Bitcoin can come in and fill the gap.

Failed monetary policy can lead to high inflation or deflation. We have seen that in both cases, Bitcoin and other digital currencies can fulfill the role of fiat currencies, and do a much better job. Bitcoin may also help in addressing liquidity issues in global trade. The market demand for Bitcoin can therefore be affected positively by failed monetary policy.