There's advantages to each one. A pegged exchange rate makes trade easier as investors don't have to worry about the value of their investments changing with the value of the currency they are denominated in. Without free movement of capital, a country can't borrow from abroad to finance investments, and trade is of course limited as you can't take your money out to buy things from other countries. Capital controls are also remarkably difficult to actually enforce.
Sovereign control over monetary policy allows a country to stop the economy from overheating, and to fight recessions. When an economy tanks, like Cyprus' clearly has, it means wages and prices have to fall for the country to regain competitiveness. If they had control over their monetary policy, they could just reduce the value of their currency, slashing real prices easily and equally across the board. Without control over monetary policy, an economy has to go through a brutal process called internal devaluation. That means wages and prices either have to be brought down through government measures, or really just from businesses going bust, and unemployment increasing, until wages and prices come down. So, pick your poison.
Under the Bretton Woods system most countries chose to forgo free capital flows (C), until that broke down largely because it was increasingly unenforceable. It is also an incredible pain, at one point people in the UK couldn't take out more than 50 pounds- difficult if your trying to retire to Spain. Now, America has a floating exchange rate (B), whereas the Eurozone is a group of countries that chose to forgo sovereign control over their monetary policy and form a currency union (A). This means you can travel across throughout the member countries without ever having to exchange currencies, which is pretty convenient really.
Unfortunately it's proving to be something of a disaster as different countries within the Eurozone are unable to engage in different monetary policy, appropriate for their different economies. The South, Cyprus, Portugal, Spain, Greece, Italy, desperately needs more expansionary monetary policy, but the North doesn't, and the Euro means they're all stuck with each other. They all have to have the same money, euros.
Unless you have capital controls, like Cyprus has just put into place. What is going on is that euros in Cyprus are clearly no longer as valuable as euros in other parts of the European Union, since euros in Cyprus have a tendency to disappear overnight when the government takes them as a special tax on depositors. They have to put capital controls in place or anyone with any sense will take them out of the country, turning them into not-Cyprus-euros. But how enforceable is that?
Right now, you've got depositors locked out of their bank accounts, but eventually you'll have to let them take their money out. And all it takes is a suitcase and you can move them into a bank in Germany where they'll presumably be safer and more valuable. The only solution I can see is Cyprus leaving the Eurozone, reverting to a sovereign currency, which Cyprus can then devalue. This will allow them to engage in expansionary monetary policy to regain competitiveness, and reduce the value of its debts through an "inflation tax".
I just can't imagine that a small tourist destination like Cyprus will be able to keep functioning without letting money in and out of the country. Capital controls are going to be unenforceable, a fixed exchange rate isn't going to be possible, while a sovereign monetary policy would clearly be highly desirable. So there's my prediction, Cyprus will leave the euro (B).
