Can Smart Contracts and Blockchain Technology Generate Better Monetary Policies?

Centralized monetary systems have shown us many times along history that they have major flaws. Constant debt acquisition or accelerated issuance and inflation are always a bad recipe. The centralized traditional monetary system has some structural flaws that generate asymmetrical wealth transfer cycles consolidating more power into fewer hands each time the cycle is repeated.

In this context, a question arises naturally: Can Blockchain technology help central banks and governments develop better monetary policies?

Bitcoin and many other digital cryptocurrencies have a total max supply and the rate at which new money is issued is fixed. At the time of writing, each time a new block is mined on Bitcoin’s Blockchain, the coinbase reward is 12.5 BTC and it´s stipulated to be reduced in the next halving process.

Could a central bank commit to unconditionally follow a fixed issuance rule?

Having a fixed issuance rule would provide both the private and public sector certainty about the expected levels of inflation. This would obviously generate many benefits, as there would be clear rules about the expected future issuance of money and the effects over its value.

In a context where legal tender would only be allocated on a Blockchain, the fractional reserve system would probably cease to exist, as there would be no need for banks and intermediaries. Bankers would no longer have a free put option to transmit their liabilities to taxpayers in the event of a default. This would also have a positive effect on the value of the currency, as it would reduce the amount of money created from thin air. Commercial banks could basically be no longer needed.

On the other hand, restricting the power of a central bank to print new money could force governments (specially in underdeveloped economies) to systematically develop monetary policies where currency issuance would no longer be an option to finance any kind of commercial or fiscal deficit. This is a huge constraint that many governments definitely take into consideration.

Now, there’s one big important question that we need to address at this point: Could there be something like a right rate of issuance? How should governments using Blockchain technology define it?

According to Milton Friedman, the real point is not that there should be a fixed money supply, but that money should be neutral. Money should grow at the rate that the economy grows because you are looking for a stable price system instead of a stable money supply. If the economy grows, there’s more demand for currency. With a fixed supply, this would increase the price of the currency whereas if you increase the supply in the same proportion, prices could (in theory at least) remain the same. Having a fixed money supply or a very low rate of growth would force prices down if the economy grows, as the purchasing power of the currency would be higher.

A fixed issuance or a fixed annual growth percentage of the currency could allow citizens to acquire debts (leasings, mortgages, etc.) without the fear of unexpected devaluation. Governments and central banks could inform and deploy the terms of the monetary policy for a fiscal year through Blockchain technology. This would increase confidence, as one of the core characteristics of Blockchain technology is its immutability.

Though there are many benefits associated with this transition both for governments and central banks, a big portion of the worldwide population may not like the idea of losing privacy. If hard cash or paper bills were no longer available, citizens would be forced to use a private Blockchain to conduct all their transactions.

Last but not least, many central banks all over the world are particularly fond of the idea of negative interest rates.  Allowing interest rates to go even further below zero could make central bank policies more effective in a situation of weak growth and very low inflation. People would probably prefer in many cases to just keep paper bills with zero interest instead. The only possible way to promote a below zero rate policy is through the elimination of traditional paper money so this issue, in particular, may also generate a lot of debate and controversy.

So as we can clearly see, Blockchain technology can indeed help central banks generate better monetary policies that could provide populations all over the world precise information about the future issuance rate and avoid intermediation costs. However, the costs of privacy invasion & negative interest rates could become important deterrents.

The big irony is that the Bitcoin idea, which was conceptually created for decentralization, could end up being co-opted by central bankers through private Blockchains. We’ll probably see a lot of changes in the upcoming years from central banking institutions on the way they create, control and inject money into the markets.