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Background

In modern economies, at least up until ~10 years ago, it was assumed that a currency would be technically able to be subjected to monetary policy, that is, where more money is created or removed via typically monetary policy means.

However, certain assets/currencies whose quantity is determined purely through software and cryptography may not be able to be subjected to the same monetary policies.

Question

To what extent can a typical cryptocurrency whose quantity is deterministic be influenced by monetary policy on that currency?

My thinking

  • Technically, an organisation (e.g. a central bank), or even individual, could technically hoard a cryptocurrency in very large quantity, and then affect some sort of monetary policy by:
    • spending more of their currency holdings to cause inflation (depreciation of the currency's worth against goods and services), or
    • buying more of the currency to make it less abundant and promote deflation as appreciation causes goods and services to be cheaper.
    • Note: the orchestrator would have to control a significant sum in order to have a detectable effect.
    • Also: although an orchestrator couldn't create more of the currency, they could permanently destroy or decrease the supply (if they were willing to pay to do so) by destroying their cryptographic account keys, which creates an interesting asymmetry in capabilities.
  • However, no organisation/government could simply print or create more of the currency, at least not in a way that wasn't predetermined by the software.

One other thing

If the practical word 'cryptocurrency' throws anyone, please substitute it with 'a currency whose quantity is deterministic'.

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  • $\begingroup$ The amount of Bitcoin is fixed at 21 e6. Production (real GDP) increases over time due to technology improvements. This leads to deflation. So Bitcoin will "not" be used to buy goods since waiting makes the price of goods in bitcoin go down. It is therefore fundamentally flawed as a currency in the real economy. Hence central banks should not buy bitcoins. $\endgroup$
    – Andy
    May 2 at 7:57
  • $\begingroup$ @Andy I've already shown (in the Q) that some elements of monetary policy are not possible, but also that at least some attempts at monetary policy are indeed possible. So the question is about the degree to which a currency with deterministic supply could be affected by MP. Also The amount of Bitcoin is fixed at 21 e6 is not quite right, it will get to that quantity by some future date and the supply grows at a fairly predictable rate until then. You're quite right to use bitcoin as an example, but this question is about any currency whose supply fundamentally deterministic. $\endgroup$
    – stevec
    May 2 at 8:07
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Well first if actually the cryptocurrency we are talking about would be created by central bank, then the rules that were used to create it would be by definition monetary policy even if supply of money would be fixed, since monetary policy is central bank’s control of money supply either directly or via interest rate (see Yeyati, Sturzenegger (2010), or Friedman 2001). Keeping supply of currency completely fixed at all times is a valid (although arguably very disastrous) monetary policy. Hence, to an extent that some monetary authority consciously sets up rules for cryptocurrency, that set of rules will, by definition, be monetary policy.

If we are talking about some independent cryptocurrency then the cryptocurrency is equivalent to being a foreign currency from a perspective of central bank. In such case we can’t talk about central bank directly conducting monetary policy for cryptocurrency as by the definition of monetary policy monetary authority has to be able to change supply of money, but despite of that monetary policy set for its own currency can still affect the exchange rate between domestic and cryptocurrency and thus it can affect the value of cryptocurrency. A loose monetary policy ceteris paribus, would depreciate USD/Bitcoin exchange rate making bitcoins more expensive (for more detailed overview of how monetary policy affects exchange rate markets see Exchange Rates and International Finance).

Central bank could decide to do what you suggested buying/selling that cryptocurrency - which is equivalent to an foreign exchange intervention. This too is technically monetary policy since this is done through control of the money supply of central banks’s currency (e.g. central bank has to create more of its currency in order to get more of the foreign currency as reserves, and conversely when it reduces the foreign currency reserves it will get the previously created money back and thus reducing money supply). Even if a central bank has no control directly over money supply of other countries this allows central banks to also to certain degree control value of other currencies. For example, in past China’s central bank was partially keeping dollar overvalued and yuan undervalued by keeping large USD reserves.

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