Could Bitcoin become the next World Reserve Currency?

Throughout modern history, the case has always been that the world’s reserve currency is the currency of the country or empire with the strongest economy and the one backed by the largest military or navy power. What is less known about the history behind reserve currencies is the cyclical tendency for that mantle to be passed to a new successor every century or so.

Due to advances in navigation and exploration, the Portugese and Spanish (who later merged to form the Iberian Union) dominated as their trade routes expanded as far as China. Their currencies became the primary currencies accepted across the entire New World for two centuries.

After the collapse of the Union, the Dutch East India Company of Netherlands started to dominate global shipping routes. At its peak, it even maintained a private army force that were larger than most countries’. This helped establish Netherlands’ currency the Guilder as the reserve currency of the day.

Before long, France flourished under Louis XIV and the French currency Livre rose to prominence. Coincidentally, the Livre was pegged to a fixed amount of gold and silver to address monetary stability.

Following the defeat of Napoleon Bonaparte, the British empire rose to prominence. However, by the end of WWI, the British government was effectively broke, with 40% of government spending going towards interest payments alone. (sound familiar?)

After the Bretton Woods Agreement led by the US in 1945, the rest is history.

Today, market commentators are becomingly increasingly convinced that the US empire is beginning to wane, and the world will soon once again go through a tumultuous period of change as central banks look towards a new and stable way to store their country’s wealth without being held hostage to the controversial monetary policy of the Federal Reserve.

We believe that Bitcoin (or a similar cryptocurrency which fulfills the censorship-resistant + Store of Value property) will play an increasingly significant role in the future of central banking.

Today, global central banks around the world hold large amounts of gold on their balance sheet and continue to accumulate more. Countries like Russia and China have been progressively vocal about their unwillingness to hold large amounts of US Treasuries and have been among the largest purchasers of gold for obvious reasons. Countries with large trade surpluses will explore any credible alternative to the USD, and have times even talked openly about it. Many smaller countries have already started accepting the Chinese Yuan for trade. Many Middle Eastern countries and other countries on sanction lists would also willingly drop the dollar and to get off the SWIFT financial payment network, which is controlled by the US.

Despite the storage challenges and liquidity issues, gold has endured as the bona fide way for a central bank to diversify savings away from fiat money, despite some very real concerns and allegations around the physical rehypothecation of gold.

From a central banker’s perspective, a reserve currency must fulfill these properties (among others):

The first global asset that fulfills all these properties to date has been for the most part gold, and to a lesser extent, silver. For the first time ever, a new possible alternative in the form of Bitcoin has begun to emerge. When evaluated properly, Bitcoin is equal to or better in every single dimension.

The most oft-heard repudiation is that Bitcoin has no intrinsic value and therefore cannot be sound money. This is incorrect.

An asset that has achieved global SoV status will by definition have two parts to its valuation: Intrinsic Value + Monetary Premium accorded by its status as a SoV. For example, if gold were to hypothetically be stripped of its SoV status overnight and the global economy only recognizes it for its current limited known set of use-cases (mostly electronics, circuits etc.), then its value would certainly drop to its intrinsic value, a small fraction of what it is being traded for today. The monetary premium that gold enjoys has absolutely nothing to do with its intrinsic value, and should be thought of as completely separate concepts.

The issue with Bitcoin forking often comes up and whether this unlimited forking potential undermines its scarcity. The late 2017 debacle between the community split of Bitcoin and Bitcoin Cash impresses on us a few lessons a posteriori. This may be the topic of another article, but suffice to say that any ideological schisms cannibalizes value from Bitcoin, and is absolutely not the fabrication of value out of thin air. When a portion of the community leaves Bitcoin, it siphons value away from it. This is not creating money out of thin air. Conceptually close to a stock split.

We would also add that it does good for the ecosystem as a whole in the way hard forks acts as a pressure release valve for the new community to exercise their right to air their idealogy in a “may the best coin win” fully democratized competition. There have been over 70 attempts to fork Bitcoin and the vast majority of attempts end up worthless. Bitcoin’s 21 million supply is absolutely very different from a newly conjured 21 million Bitcoin [insert new variant]. You can fork code, but you cannot fork a community. However, successful ideological forks of Bitcoin have happened with unique propositions that does not try to compete directly with Bitcoin such as Zcash which have then since forked to Zclassic, and then most recently Zencash. All 3 communities today are well and alive (although I expect Zclassic and Zencash to lose their small communities over time)

The other issue is continuity. Gold has withstood the test of time while Bitcoin has not. However its fair to say we’re in the price discovery stage and that a mature SoV asset would not be trading at the current valuation of a mere US$100 billion. Depending on where one values Bitcoin at ultimately, the price accorded to it by the market today can be interpreted as the Bayesian probability that Bitcoin eventually ends up as the dominant global SoV. In a hyperbitcoinization scenario, a case can be reasonably made for a single satoshi to be worth at least a cent although valuation is out of the scope of this article.

Bitcoin’s price continues to remain volatile, but as the market matures and more institutional participants enters the ring, expect volatility to dampen. Bitcoin’s volatility appears to be falling over time (red line), with each peak in volatility lower than the last. As the asset class grows larger and more entrenched in the global capital markets, more capital will be required to move prices around, leading to a more stable market over time.

In order for Bitcoin to become a credible self-sovereign SoV we believe a few things must first happen and in no particular order:

There are other issues to contend with, like the transmission of monetary policy (or even whether its necessary for governments to do so) and how to enforce taxation in a hyperbitcoinized world, but this is not the point of this article. This article barely scratches the surface, and I expect more rigorous discussions around Bitcoin acting as a global reserve currency in the decades ahead.

I would also point out that this does not necessarily mean that Bitcoin will become the dominant SoV. There is a non-trivial probability that another cryptocurrency may emerge that will take its place, especially in edge-case, price-binary scenarios such as if Bitcoin has a severe exploitable bug. As far as open source protocols goes, the market is fair game for any up and coming cryptocurrency, just like in 2011 when competitors to Bitcoin first emerged. However, the longer the Bitcoin exists, the more likely it’ll continue to exist and capitalize.

We leave you with this thought. If one day a reputable central bank were to suddenly declare that they have successfully diversified their balance sheet to include a certain percentage of cryptocurrencies, how would the other central banks around the world react?

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