Objective: Introduce central banking tools like monetary policy and compare them to crypto's decentralised model.

Outcome: Understand how monetary policy impacts fiat, stablecoins, and Bitcoin.

Introduction

In the last lesson, we explored the forces of inflation and deflation, highlighting Bitcoin’s unique role as a hedge against both. Now, we turn to one of the most powerful tools of centralised finance: monetary policy. In this lesson, we’ll examine how central banks use monetary policy to influence economies, compare it with the decentralised nature of cryptocurrencies, and explore the implications for fiat, stablecoins, and Bitcoin.

What Is Monetary Policy?

Monetary policy refers to the strategies employed by central banks to regulate a nation’s economy. These strategies include controlling the money supply, adjusting interest rates, and managing inflation or deflation. The two main types of monetary policy are:

1. Expansionary Monetary Policy

This approach aims to stimulate economic growth by increasing the money supply and lowering interest rates. While this can boost consumer spending and investment, excessive expansion can lead to inflation. For example, during the COVID-19 pandemic, central banks worldwide adopted expansionary policies, printing trillions of dollars to support struggling economies. However, this devalued fiat currencies, fuelling demand for alternative assets like Bitcoin.

2. Contractionary Monetary Policy

In contrast, contractionary policies aim to curb inflation by reducing the money supply and raising interest rates. While effective in controlling rising prices, these policies can slow economic growth. For instance, the Federal Reserve’s recent interest rate hikes to combat inflation have increased borrowing costs, leading to reduced economic activity.

Cryptocurrencies: A Decentralised Alternative

Unlike fiat currencies, cryptocurrencies operate on decentralised networks that are not subject to central bank control. Let’s explore how this decentralisation creates a stark contrast with traditional monetary policies.

Bitcoin’s Predictable Supply

Bitcoin’s supply is capped at 21 million coins, governed by its protocol rather than a central authority. This predictability makes it immune to inflationary pressures caused by excessive money printing. For example, while the US dollar’s purchasing power has declined due to inflation, Bitcoin’s scarcity has driven its long-term value appreciation.

Stablecoins: Bridging Fiat and Crypto

Stablecoins like $USDT and $USDC aim to combine the stability of fiat with the transparency of crypto. Pegged to fiat currencies like the US dollar, they provide a stable medium of exchange in volatile crypto markets. However, they rely on reserve systems, raising questions about centralisation and trust.

100 us dollar bill
Photo by Giorgio Trovato / Unsplash

Decentralised Finance (DeFi) and Monetary Control

DeFi platforms, such as $CRV, challenge traditional lending and borrowing systems by eliminating intermediaries. These platforms offer financial services governed by smart contracts, providing greater transparency and efficiency compared to centralised banks. For instance, while banks adjust interest rates based on policy decisions, DeFi rates are determined by market dynamics.

Real-World Implications

  1. Quantitative Easing and Bitcoin Adoption: Central banks’ reliance on quantitative easing often devalues fiat currencies, prompting investors to turn to Bitcoin as a store of value. During the 2020 pandemic-induced stimulus, Bitcoin’s price surged as institutional and retail investors sought inflation-resistant assets.
  2. Stablecoins in Emerging Markets: In countries with volatile currencies, stablecoins provide a crucial bridge, enabling cross-border transactions and preserving wealth. For example, $USDT is widely used in regions like Latin America for everyday transactions.
  3. DeFi vs Central Banks: By offering decentralised financial services, DeFi platforms reduce dependency on centralised monetary policies, empowering users to control their assets directly.
A building with a large wooden door on the side of it
Photo by Julio Lopez / Unsplash

Conclusion

This lesson highlighted the contrast between centralised monetary policy and the decentralised nature of cryptocurrencies. Bitcoin’s fixed supply, stablecoins’ bridging role, and DeFi’s disruption of traditional systems illustrate how crypto challenges central bank dominance.

Module Summary: Foundations of Economic Thinking

In Module 1, we explored the fundamentals of economic thinking, starting with the principles of value creation and culminating in a comparison of centralised and decentralised monetary systems. Along the way, we examined the evolution of money, the global dynamics revealed by PPP, and how Bitcoin addresses inflation and deflation. These lessons provide a solid foundation for understanding the mechanics of markets, which we’ll cover in Module 2.

In the next module, we’ll dive into topics such as 24/7 crypto trading, the parallels between bonds and staking, and how economic indicators influence crypto markets. By linking traditional economic concepts to crypto applications, we’ll uncover new strategies for navigating the ever-evolving crypto ecosystem.