What Are Reserve Assets; Can Bitcoin Become One?

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Reserve assets can be currencies or any other assets, such as gold or silver that can be used for international payments, investments, and other aspects of the global economy.

Currently, one of the most common reserve currencies is the US Dollar. As per the International Monetary Fund (IMF), roughly 59 percent of all foreign bank reserves are currently held in US Dollar.

However, last week, Credit Suisse – the Swiss global investment bank – released a report predicting an imminent and radical change to the world’s monetary system. It stated that, given the soaring inflation in the west and geopolitical tension in the east (the Ukraine-Russia war), a “new monetary order” could emerge, in which Bitcoin could be an unlikely beneficiary.

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One of the main contributors to the report was former Federal Reserve and US Treasury Department official Zoltan Pozsar, now the short-term rate strategist for Credit Suisse (CS). In his note, Zoltan wrote, “This crisis is not like anything we have seen since President

He concluded his note with a comment on Bitcoin, which he believes will benefit “if it still exists” at the end of the crisis, hinting at the possibility of Bitcoin becoming the next global reserve.

How do reserve assets work and their history:

Reserve assets are commodities, currencies, or other capital held by institutions and countries as a hedge against global market fluctuations caused by external factors. They play an essential role as a cash reserve in the balance sheets of many entities. They are meant to be an independent store of value that is not affected by market volatility.

In the 19th century and earlier, precious metals like gold and silver were used as universal commodities that people could use to efficiently store value for their labour. But due to the limitation of not being able to use them daily, paper currencies were used as a layer of abstraction backed by a portion of gold stored in a safe location.

As World War II ended, leaders from 44 countries came together to sign the Bretton Wood agreement. Under this agreement, the value of the US dollar would be pegged to gold, and other currencies would, in turn, be pegged to the dollar. However, this system began to fall apart over time and was eventually abandoned in 1971, when President Nixon took the dollar off gold, as mentioned earlier.

Ever since then, the international community has used a simple fiat currency model. Here, the currency is only backed by faith in the government itself and its value is driven by marketplace forces of supply and demand.

The problem with the current system:

This system has its fair share of problems. For instance, countries that want to serve their fiat currency as a global reserve asset must run a continuous trade deficit to provide enough to supply the global demand.

Moreover, to meet this demand, the central banks of the world’s major economic powers can easily print fiat money out of thin air. Over time, this has led to more than 10,000 billion dollars being injected into the system. And in the case of the US, it could be one of the major reasons why inflation is so high.

Currently, US dollar inflation is at its highest in 40 years, with CPI in January showing a 7.5 percent price increase YoY. Combine this with the sanctions on Russia and the economic fallout of its conflict with Ukraine, and we could be on the path to a “new monetary world order”, as predicted by the note from Credit Suisse.

How can bitcoin as a reserve currency solve the problems we face today?

Today, institutions face many threats to the value of their stored reserve assets, including inflation, weakening purchasing power, international competition, and others. Entities are looking into alternative reserve assets that are scarce and cannot be affected by third-party forces. Cryptocurrency like bitcoin shows a lot of promise as it is decentralized.

Bitcoin is a decentralized system of storing transactional data. Data storage is done on blocks on a public ledger/database. This means that there is no centralized authority controlling the changes and actions happening in the database.

Instead, the transactional data in the bitcoin blockchain is verified by a network of peers who all hold a copy of the database/ledger. This means any changes or actions in the database have to be verified and approved by all the nodes in the network. This makes the bitcoin blockchain structure secure and immutable. Bitcoin as a reserve asset will remove the element of third parties controlling the structure, essentially removing their influence on the currency itself.

Moreover, when bitcoin was launched by its mysterious creator, Satoshi Nakamoto, he embedded a set limit of bitcoin tokens that can be introduced in the blockchain. This limit was set at 21 million tokens. A limited supply makes bitcoin a scarce asset and an excellent hedge against inflation.

Removing central intermediaries in the transaction process also makes the system fast. Further, with only wallet addresses attached to a person taking part in transactions, bitcoin provides a better level of anonymity than fiat currencies as well.

In his note, Zoltan wrote that “money” will never be the same again after the Ukraine war, and bitcoin may be a beneficiary. How far this is true, only time will tell.

(Edited by: Priyanka Deshpande)

First Published: Mar 15, 2022, 01:49 PMIST

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