Nations transact in US dollars, even when they don’t use them internally and neither of them is the US. Corporations sit on trillions of dollars globally in cash reserves, even when they’re headquartered outside the US. And local governments hold and invest pension funds and reserves too.
Right now, that means dollars and bonds, and occasionally gold. But those institutions that rely on investments are diversifying in the face of falling yields; those that prefer cash are facing diving interest rates. The world is in need of a currency/asset hybrid that can fulfill the role of the dollar and the bond, offering high yields and rapid liquidity globally. Could Bitcoin be it?
What is a reserve currency?
Reserve currencies, sometimes referred to as “anchor currencies”, are usually foreign currencies held in reserve by organizations. They’re used for foreign trade, and as a kind of floating backer to the national fiat currency. You can think of them a little like a country’s savings account, though we’ll see that they don’t really work that way.
Traditionally, reserve currencies have preferentially been the strongest and most stable of world currencies; in the late nineteenth century, the world reserve currency of choice was the British pound, and by the end of the twentieth century it was the American dollar. In the case of the dollar, a free-floating fiat currency, reserve currency status has benefits for the US economy, allowing the American state to borrow more cheaply.
Historically, the reserve currency of choice has been synonymous with the strongest local power: in the fourth century AD in Europe, educated people spoke Latin and the reserve currency was the Roman Denari. Roman power was reinforced by the legions and sweetened by the availability of Roman export and empire-wide trade goods. The British Empire’s maximal extent of power and economic might coincided with the high point of its currency. The dollar rivals US English for its global reach. But American soldiers travel too. Can you have a reserve currency without the soldiers and without it being pegged to a specific economy? We’re about to find out.
National reserve currencies
National reserve currencies are the walletful of (currently) dollars that countries keep on hand to transact foreign trade; they constitute a kind of financial lingua franca. But reserve currencies can also be used to back the country’s own currency. Panama pegs the balboa 1:1 with the US dollar, for instance. In this sense, reserve currencies also act the way gold used to, as a solid basis for a country’s own currency. Although the dollar is a fiat currency, it can be used as an underlying asset for fiat currencies — as well as for stablecoins, of course. There are also smaller or less-developed countries that rely on the dollar as their primary national currency, some of which issue their own bond currency — tokens for dollars — rather than an independent currency of their own.
A nation’s relationship with its reserve currency (or currencies) can be complex. Nations borrow in their own currencies, as a rule, and these are all now fiat currencies, meaning nations can spend money into existence at need. However, they can’t print dollars (the obvious exception aside). Thus, the supply of dollars is inelastic and the supply of local fiat currency is elastic, meaning the value of dollars tends to rise. And as the price of the dollar goes up, so does its desirability as a stable bulwark against a weak or wobbly local currency. The balance between the two is a major policy goal and preoccupation.
Local and state reserve currencies
Nations aren’t the only administrative units that keep money reserves. City, state (as in subnation administrative units in federal countries like Germany or the US) and other administrative units keep their own reserves. They’re often tasked by central governments with collecting local taxes and managing local services, as well as managing their own finances.
Unable to print their own currencies and thus barred from the Keynesian solutions nations often at least partially turn to, cities and states often use investment portfolios to improve their finances. In many cases, then, they don’t have reserve currencies so much as reserve assets — safe-haven investment targets whose value is nearly certain not to fall. State and city investment funds, along with pensions and sovereign wealth funds, constitute a major portion of the institutional investment flows that underlie the long-term growth in BTC value.
For example, Miami mayor Francis Suarez says he is considering putting some of the city’s treasury reserve funds into BTC, saying:
“if I would have done it last year, I would have made 200%-plus [return]. So I would have looked like a genius”.
Mayor Suarez’ move is part of an overall attempt to make Miami “one of the most crypto forward and technological cities” in the US, with an eye to “laws from Wyoming, Wisconsin, and New York, a regulatory environment”.
Suarez told Fox News considering
“being able to make payments in crypto, in bitcoin, in particular, being able to pay your taxes, being able to pay fees to the city”.
However, as the value of BTC continues to rise in the medium and long term — short-term volatility notwithstanding — and with no return to a high-interest rate environment in sight, tech-minded administrators like Suarez will inevitably be joined by those simply seeking reliable returns.
Private reserve currencies
Corporations also keep reserve currencies and asset reserves, both to bolster their internal economies and to facilitate “foreign” trade — in the case of corporations, trade with other corporate entities and trade across national borders.
It’s also crucial for corporations to soak up excess liquidity. It profits a large corporation nothing to have bundles of cash lying around, or dollars sitting in bank accounts; yet they have a balancing act to perform. On one side, access to liquidity can be crucial; on the other, excess liquidity is money wasted that could be generating a return.
In addition, cash deprecates. Over time, cash reserves can be inflated away. So corporations look for reserve assets that can grant liquidity when required but that are also capable of generating yields in the meantime, with the rate of inflation representing a minimal acceptable yield.
Common choices used to be US dollars, bonds, and gold — similar choices to those made by governments. But these assets are all underperforming currently: bond yields have all but vanished, a roaring stock market notwithstanding; the US dollar fell by around 5% in 2020; and gold is producing lower yields than it used to. One asset is consistently generating yields, though: Bitcoin.
As economist Saifedean Anmous told CoinTelegraph, Bitcoin offers companies a solution to
“longer-term critical problem faced by many companies of the diminishing yields they can get on their cash reserves by holding them in banks or treasury bonds… there seems to be a growing segment of companies that no longer reasonably expect [treasury bond yields to outperform inflation] into the future”.
(It’s worth observing that where Bitcoin leads, Ethereum and other digital assets typically follow.)
The dollar as a reserve currency
Over 60% of world banks hold currency reserves in dollars, and many commodities are priced in dollars — including crucial financial and economic staples like crude oil, natural gas, gold and silver, copper, wheat and soybeans. About 85% of global foreign exchange transactions are in dollars. The Euro is the nearest competitor, with 20% of world reserves held in Euros.
But the dollar has some drawbacks as a global reserve currency. It largely owes its role to US economic hegemony in the post-World War II years, when it was the keystone in the Bretton Woods system. The Bretton Woods agreement replaced the restrictive gold standard of the pre-1914 world and the relative chaos of the free-floating, untethered currencies of the 1930s with a system of mutual convertibility based on the US dollar, itself convertible to gold at a fixed price of $35 the Troy ounce. This cemented the dollar as the core of the world financial system — until 1971, when pressure on the US economy and the need to devalue the greenback took the country out of the system and effectively ended it.
Increasingly the world is tripole: the Americas deal in dollars, the Eurozone in Euros and Asia uses the Yen. The supremacy of the dollar had drawbacks for many users; for instance, Australia might have to exchange Australian dollars for US ones, then US dollars for Yen, to transact with Japan; increasingly that’s no longer the case.
The dollar is likely to remain a significant world reserve currency, but without being the only one; expect to see a fall in reserves held in dollars and in dollar transactions.
In addition, the US dollar is forecast to fall sharply in value over the next year, perhaps by as much as 20%. Even if it performs twice as well as in 2020 and falls only 2.5%, a million dollars in cash would lose $25,000 in currency fluctuation.
The picture isn’t as bad as first glance makes it out, because the Covid-stricken US economy is down to around 0.62% inflation as against an average of around 2.4%, but a return to the norm could wipe fifty thousand dollars off our hypothetical million in a single year — with nothing to show for it.
At the same time, there are clear advantages to the world in having a common unit of exchange; the dollar was preferable to none, but there are now other options. No national currency has the sway or the reliable value to replace the dollar entirely, or to achieve a hegemonic position as the global reserve currency; a tripartite reserve currency arrangement (USD, YEN, EUR) would create de facto borders at each zone and levy a price for crossing them, which is both undesirable and at odds with a world which is increasingly globally connected.
What’s needed is a single reserve currency not under the control of a state (so there are no direct political issues with using or holding it), doesn’t deprecate with inflation, and allows entities to transact across national borders. BTC fits the bill.
BTC as a reserve currency
Currently, there are 23 companies around the world holding 3.74% of all BTC, or around $30.5 billion (approximate, January 2021 prices). Business intelligence firm MicroStrategy led the charge, commenting on the occasion of the purchase of 29,646 Bitcoins on December 21, 2020 that “the acquisition of additional bitcoins announced today reaffirms our belief that bitcoin, as the world’s most widely-adopted cryptocurrency, is a dependable store of value”. In the three weeks since (to time of writing), those Bitcoins more than doubled in value. MicroStrategy is well aware of this and has increased the size of its convertible debt offering from about $600m to over $1bn so it can buy more Bitcoin.
Tesla is a major BTC buyer too. Elon Musk is a longtime crypto enthusiast whose Tesla electric carmaker, seeking “more flexibility to further diversify and maximize returns on our cash”, bought $1.5bn in Bitcoin prior to the end of the 2020 financial year. Tesla has thus made greater profits from its BTC investment than from sales of its cars.
Payment processor Square is less invested monetarily, but has about 1% of company assets in BTC and holds that the digital asset has the potential to become the world’s reserve and transaction currency — a view held by CEO Jack Dorsey. Institutional investment company Grayscale now holds 450, 000 BTC.
These are tiny sums as compared to the trillions of dollars held in corporate reserves around the world. However, they are indicative of a wider trend — and @jack isn’t the only one who thinks so. Many companies are diversifying into alternative investments, and if just 5% of the $13.4 trillion in alternative investments as of 2018 were invested into BTC, it could cause sharp price rises and help move toward a tipping point where BTC is regarded as the go-to safe haven investment as well as the best-performing alternative investment.
BTC as a transaction currency
BTC is worth too much now to be useful for retail transactions. No-one wants to buy a pizza or a pair of jeans and ask the merchant to make change for a Coin worth fifty thousand dollars; you may as well pay in diamonds. But there are solutions — wrapped digital assets, stablecoins, and Satoshis all break down the value of BTC into sums consumers can actually use. And this may be an area where Metcalfe’s Law applies — the value of the digital assets community as a currency rather than an asset has barely made itself felt. But we’re talking about a kind of currency that allows for instant, totally secure transactions anywhere in the world. Consumers want that. They just can’t have it — yet. The technology exists but the network is too small.
Businesses want it too. And they can transact in BTC. Those transactions can be reasonably quick while remaining fully secure. They can be as simple as a retail bank transaction and as safe as an institutional transfer with a 2-week wait time and thousands of dollars in handling and currency conversion fees.
Finally BTC can offer a truly global reserve currency precisely because it has no “home”. Keep your country, state or company’s wealth in dollars and you’re yoked to the USA, at least to some extent. (The USSR kept dollar reserves; the idea still holds.) Yen are Japanese, Euros are European. BTC are BTC. They have no home but the nonlocal blockchain. Using them commits you to the transaction, but nothing else.
Conclusion
BTC is the currency-asset that outperforms currency and assets — even on their home ground. Currently, the signs of BTC becoming the world reserve currency are on the horizon, rather than under our noses, but they’re there. BTC is qualified for the role, when little else is. And it’s more valuable even than dollars. Companies are starting to buy in quantity. Cities are interested. State governments won’t be far behind; even those that prefer a Central Bank Digital Currency may find themselves needing BTC reserves for foreign trade. The transition is likely to come quickly, and we could have already witnessed the first steps.