Can Bitcoin become a reserve currency?

What are reserve currencies?

A reserve currency can be defined as a broad amount of currency held by central banks and other traditional financial institutions to conduct international transactions, international debt obligations, investments, or to influence the domestic exchange rate.  

For example, many commodities, such as oil or gold, are priced in a reserve currency. This causes countries worldwide to hold the reserve currency to be able to pay for these goods.  

Reserve currencies reduce the exchange rate risk—countries don’t need to exchange their currencies for the reserve currency to participate in international trade. That’s why reserve currencies are used to facilitate global transactions. 

The International Monetary Fund (IMF) as the body responsible for monitoring the international monetary system, acknowledges 8 major reserve currencies- the U.S dollar, the Australian dollar, the British pound sterling, the Canadian dollar, the euro, the Chinese renminbi, the Japanese yen and the Swiss franc. The U.S. dollar makes up 59% of global foreign exchange reserves. 

Requirements for becoming a reserve currency

In simple terms, a reserve currency refers to money that countries don’t put in circulation but keep in banks to trade with other countries. 

For a currency to gain the status of a reserve currency, it must be accepted by most of the world’s capital markets, and it should maintain a value that has been agreed on by all parties using it.

How did the U.S. dollar become a global reserve currency?

Since the end of World War II, the U.S. dollar has been the most-held reserve currency and a widely used fiat currency for international transactions and global trade. To understand the U.S. dollar dominance and journey we need to go way back in the past.

 It is also believed that the U.S. dollar could remain as the world's reserve currency for the foreseeable future since it will take some time for other candidates to reach the same amount of purchasing power and influence as well as acceptance by all major financial institutions.

Even though the international monetary system has evolved over the past decades in response to shifts in the global economy pursued by technological developments, macroeconomic events, and financial integration, the currency composition of international reserves has remained stable.  

The U.S. dollar upheld its dominant position for more than 60 years, going through significant shifts in the international monetary system. Some of these shifts have included, for example, the collapse of the Bretton Woods system in the 1970s, the introduction of the euro, and trends toward greater reserve diversification. 

What is reserve diversification?

The U.S. dollar's global dominance has been brought into focus several times due to higher degrees of geopolitical risks and stricter monetary policy.  

According to International Monetary Fund’s data on currency composition of official foreign exchange reserves pointed to a continuous decline in the U.S. dollar’s share of allocated foreign reserves, and the fact that the dollar’s reduced role wasn’t matched by increases in the shares of other big currencies such as the euro, pound yen. 

In contrast, the gradual decline of the U.S. dollar has been accompanied by a rise in the share of nontraditional reserve currencies such as the Australian and Canadian dollar, Singaporean dollar and the Chinese renminbi. 

Long story short, nontraditional reserve currencies became an attractive option to reserve managers because of their yields, diversification abilities as well as their compatibility with the development of new financial technologies. 

Talking about Bitcoin

During the 2024 U.S. presidential election, Donald Trump promised at a Bitcoin conference in Nashville to create and maintain a strategic national Bitcoin reserve and stated his support for Bitcoin mining in the United States.  

While Trump added that if the U.S. doesn’t do it, then China will as one of his motives for a large-scale Bitcoin adoption, his statement was followed by Senator Lummis proposing to introduce legislation related to a strategic Bitcoin reserve to reduce the country’s national debt. 

However, it caused a debate about whether Bitcoin could become a global reserve currency. The U.S. is not the only country considering this since several other countries have implemented similar policies. For example, El Salvador adopted Bitcoin as a currency and added it to its national reserves. 

What is a strategic Bitcoin reserve?

A strategic reserve refers to external assets that are available and under the control of financial authorities. The main purpose of strategic reserves is to influence the exchange rate in foreign exchange markets.

Strategic reserves can encompass gold, foreign currency, and raw materials such as oil; and now we’re talking about Bitcoin strategic reserves.

The 2024 Bitcoin Act proposal

When talking about Bitcoin strategic reserves in the United States, the contemporary proposal refers to the Bitcoin Act. The regulatory project provides for the Treasury and the Federal Reserve to purchase 200,000 Bitcoins each year over 5 years until reaching 1 million units which further refers to approximately 5% of the global supply of Bitcoins. 

The next step is to maintain the strategic reserve for a minimum of 20 years to hedge against the devaluation of the U.S. dollar, helping with future debt problems, and enhancing national balance sheets. 

The proposal to purchase Bitcoin consists of two main elements- first, the surplus that the Federal Reserve returns to the Treasury would be used for purchasing the cryptocurrency. The second element relates to central banks of each federal state to reassess their gold certificates to better reflect the value of gold in the current market and deliver the difference to the Treasury which would keep on buying Bitcoins. 

Can Bitcoin become a reserve currency?

One of the biggest upper hands of Bitcoin as a reserve currency is linked to its scarcity. Bitcoin has a fixed supply of 21 million coins and an inflationary mechanism. This mechanism is attractive to countries that seek a reliable store of value and a novel medium of exchange.  

Additionally, Bitcoin’s decentralised nature removes the need for intermediaries such as central authorities and banks, making the reserve currency less vulnerable to fraud and manipulation. 

The third notion refers to crypto assets becoming an important economic tool in the future, and it seems this might happen sooner rather than later. As stated above, crypto assets have the potential to resolve one of the main flaws of the traditional financial system- centralisation.  

Due to blockchain technology, the ledger of available cryptocurrencies is scattered across every computer in the network which makes it almost impossible to hack or alter.  

Arguments against Bitcoin becoming a global reserve currency

The counterargument is simple- it is considered that Bitcoin might not be currently stable enough to become a reserve currency. Experts often point out that Bitcoin’s volatility is the main factor stopping it from integrating with global capital markets and becoming a reserve currency.  

The price volatility of Bitcoin amplifies risks in the global markets, rather than hedging them. At least for now. And there is also a concern whether the current system is able to assimilate Bitcoin as a reserve currency since it represents a different concept.

On the other hand, Bitcoin’s limited supply is one of its main advantages but a double-edged sword as well- the hard limit of 21 million Bitcoins could be a problem for the cryptocurrency becoming a global reserve currency. 

To learn more about crypto assets, take a look at our Learn Crypto Academy.