Unit 7 Lecture Notes

Based on the discussion above, it is my belief that bitcoin's health is largely (but not always) an inverse function of the quality of the monetary and financial policies of the world's governments and central banks. We could divide government monetary policies into six different scenarios, and assess their impact on bitcoin:

1. Monetary policies worsen
2. Monetary policy continues as usual
3. Improvements in monetary policy
4. A government bitcoin standard
5. A government gold standard
6. A free market in money

For Case 1, imagine a world with 10 more Venezuela's and a growing number of people in desperate need for a hard money. Demand for bitcoin would rise, and its liquidity would continue to increase, potentially rivalling gold. This scenario would likely witness many hyperinflations and currency wars, and the longer it continues, the more liquidity bitcoin amasses and the more likely it is to emerge as money in the future. The worse the monetary policy is, however, the faster these collapses happen, and the less likely bitcoin's liquidity will grow to a level allowing it to compete with gold in the future.

Case 2 would be the continuation of the current state of affairs with mildly inflationary monetary policy in most countries, and a few basket cases of hyperinflation and high inflation around the world. In this scenario, demand for bitcoin continues to grow gradually and we would be likely to experience the 'smooth upgrade' scenario for bitcoin adoption discussed above.

Should monetary policy improve, as in Case 3, one would expect demand for bitcoin to subside, and though it may survive, it will likely continue as a small niche technology whose main value is in providing citizens with a chance to escape their governments' worst monetary policies, which in turn likely puts a limit on how bad government policies become, which in turn slows down bitcoin growth an adoption.

Should governments adopt bitcoin as their monetary standard, that would likely increase bitcoin's liquidity enormously, and likely make it the dominant form of money in the world, but do not count on this happening any time soon.

In case 5, a further improvement in monetary policy through the adoption of a gold standard, would likely be the most effective government weapon to fight bitcoin, allowing governments to stifle its growth while maintaining some control over the financial and monetary systems.

Finally, in case 6, a completely free market in money, or the absence of monetary policy, is the best monetary policy possible, and in that case, bitcoin would arguably lose its raison d'etre, and unless it had built up a very large liquidity pool by then, it will likely fail to dislodge gold as the world's prime money.

Bitcoin's survival and success is more likely in the scenarios in which the world's central banks' policies are similar to those that have prevailed over the past few decades, not much worse or better. Improvements in central banks' monetary policies, lower inflation and fewer business cycles would likely reduce demand for bitcoin. A severe worsening of monetary policy which would lead to more widespread collapse of national currencies could also jeopardize bitcoin if it results in more free market competition between monetary alternatives without government intervention, at a time when bitcoin still has very little global liquidity. The good news for bitcoin is that the most likely courses of action for governments for the foreseeable future are in its favor. The bad news for bitcoin is that by being built to resist government control, it is inevitably and inextricably affected by how governments behave, and might in fact be reliant on their monetary policies not improving or deteriorating too much for its survival.