Bitcoin Monetary Policy

What is Monetary Policy? And why does it matter?

Monetary policy is the process by which the monetary authority of a country, typically the central bank (in the US the FED and in Europe the ECB), controls the money supply and the cost of short-term credits. With the monetary policy, the central banks influence inflation and the interest rate to ensure price stability and trust in the currency. That’s the official description of what central banks should do.

Further goals of monetary policy are usually to contribute to the stability of the gross domestic product, to achieve and maintain low unemployment, and to maintain predictable exchange rates with other leading currencies.

The central banks (Fed or ECB) increase the monetary base by issuing currency, increasing either the amount banks have on reserve or by a process called Quantitative Easing. This process is similar to printing Fiat money, although it happens digitally. Via the expansion of the money supply, central banks devaluate the currency.

After all, fiat currencies are not backed by any tangible assets. Fiat currencies (like the US-Dollar, Euro, Pound, Yen, etc) are backed by the full faith and credit of the government that issued them and nothing more. They are not backed by any tangible asset. If you want Gold, Diamonds, Bonds, Stocks you need to buy these with your Fiat currency from a person or company.

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The Bitcoin Monetary Policy

Bitcoin is a fully decentralized Blockchain and not banking system. In a fully decentralized monetary system, there is no central authority that regulates the monetary policy. The monetary policy of Bitcoin is coded into the software and Bitcoin currency is created by the miners of a peer-to-peer network. The Bitcoin generation algorithm defines, in advance, how the currency will be created and at what rate. Any Bitcoin currency that is generated by a malicious user that does not follow the rules will be rejected by the network and thus is worthless.

Bitcoins are created each time a miner discovers a new block. The rate of block creation is adjusted every 2016 blocks to aim for a constant two week adjustment period. The number of bitcoins generated per block is set to decrease geometrically, with a 50% reduction every 210,000 blocks, or approximately four years.

The hardcoded Bitcoin monetary policy ensures that the number of bitcoins in existence will not exceed 21 million. The exact figure is 20999999.97690000 BTC in the year 2140. The Bitcoin supply is based on the following formula:

bitcoin supply formula how bitcoin supply works

Cumulated bitcoin supply

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