Complicated matters that could have massive implications on the global economy.
Since Bitcoin (BTC) was launched into the market, many cryptocurrency enthusiasts argue that Bitcoin is the best alternative to the reserve currency. Especially when we think about the disastrous implications of infinite money printing, Bitcoin and various cryptocurrencies could be used to protect the value of local currencies. Here, we’ll have a look at whether cryptocurrencies could become reserve currencies and what kind of cryptocurrencies could be reserve currencies for central banks.
Before we get into the topic, let’s have a discussion about the definitions of Money and reserve currency.
So, what is money?
Money can be defined as a medium of exchange, store of value, unit of account, and a policy instrument. In other words, money is used to pay for goods and services, save up for the rainy days, and a stable place where you could store.
So, what is reserve currency?
Reserve currencies are a large quantity of currency maintained by central banks and other financial institutions to prepare for investments, transactions, and international debt obligations, or to influence domestic exchange rates. Reserve currencies affect the prices of most commodities and many institutions would have to hold reserve currency to pay for these goods so that they could be used for production.
What are the characteristics of reserve currencies?
-Minimal risks to currency-related to economic environments
-Being liquid and widely accepted medium of exchange around the World
-Having reliability on global affairs
-Having network externality on a global scale
-Easily tradeable low-risk assets
What were reserve currencies before the US government has turned into fiat currency?
Throughout history, there were various commodities were used as reserves for countries. However, sovereign states used gold, silver, bronze, copper, nickel, and other valuable items as some sort of reserve currency so that it could bolster the local economy. Now, let’s have a look at various commodities:
Throughout history, sovereign states have used gold to stabilize their economy for various reasons. First, gold was rare earth metal and it was hard to be extracted. Therefore, it had great value and sovereign nations could generate currencies that have considerable value to influence local and international markets. Secondly, the value of gold is relatively stable and it only has a deflationary feature as it’s hard to be extracted and to be put to market. As a result, sovereign nations and wealthy nobles could accumulate wealth and having sufficient amounts of reserves to support their payments in times of need.
Despite gold was the most commonly used reserve to hold currencies, governments still used silver to some extent. The use of silver could be entirely used to generate a currency that is inferior to silver, mixing with the main currency so that the main currency of states could be issued more to the market or just purely used as a solid reserve currency. Despite some civilizations used silver entirely as a reserve currency as it was more abundantly extracted than gold, most nations preferred the use of silver to devalue their currencies when nations had a hard time managing the budget and the economy. This could be depicted from the Roman Empire and Ottoman Empire as they had economic hardships.
Bronze was the most abundant resource as it was relatively easy to be produced from copper. This has resulted in nations creating bronze coins as the most inferior money possible as bronze was the most common medium of exchange in most jurisdictions and governments would nominate values for exchange rates of silver and then gold. Similar to silver, bronze could be used to devalue the main currency in a state if governments have issues related to money demand and the balance of payments.
How are commodities being pulled back from currencies?
Before the US government removed gold as the primary reserve of the US Dollar (USD), money printing would be correlated with the total market value of gold. But when the US government had issues with their balance on payments since the 1960s due to Vietnam War and welfare programs, the US government had to give up on their gold reserves to cope with the payment deficit. When governments realized the issue in the US Dollar, governments started to sell US Dollars and entirely converting their USD reserves into gold. As a result, the US government had resorted to removing the gold reserve out of the US dollar to make it a widely used currency so that the US government could keep control of the global money supply and pay budget deficits.
Cryptocurrencies as reserve currencies
Since Bitcoin was launched into the market, many enthusiasts suggest that some cryptocurrencies could be used as the reserve currency to balance the spending habits of most financial institutions. Despite Bitcoin was initially proposed as a reserve currency, Ethereum (ETH) and Binance Coin (BNB) also became popular reserve currency options as they were being battle-proven in the blockchain space.
Why did some parties recommend the use of prominent cryptocurrencies as reserve currencies?
In reserve currencies, governments could only generate money in proportion to the market cap of a certain commodity. As the primary reserves are generally difficult to extract and being driven to markets, primary currencies would become valuable because of scarcity. When looking at Bitcoin, because it’s been extracted by mining and block rewards being reduced over time, the scarcity factor plays a massive role within currencies and limiting the local currency supply and increasing the value. On Ethereum, mining was the only option before Ethereum 2.0 being introduced. The good part of Ethereum is that it is one of the most difficult cryptocurrencies to be extracted even with staking. To stake Ethereum on the contract address, a wallet needs at least 32 Ethers to lock at the contract address and there’s a vesting period and an annual percentage yield to preserve the value. In short, cryptocurrencies could be used to bolster local money and to protect the value of Money against financial and economic shocks.
What lies in the way cryptocurrencies becoming reserve currencies?
-Too much money supply through the global economy,
-Government monopoly on money,
-Government experiments on central bank digital currencies (CBDCs)
-Scalability issues as Ethereum could support 15 transactions per second and Bitcoin only supporting 7 transactions per second. Even more, Ethereum boasts the highest fees on transactions. However, Ethereum could turn the tide with Ethereum 2.0 with fee structure and scalability.
Despite El Salvador accepted Bitcoin as a reserve currency and several nations consider using Bitcoin as reserve currencies to mitigate the effects of economic theaters. In this plan, governments that have a very limited money supply could use Bitcoin to bolster the value of their money in global markets. However, governments could only print as much money to the market value of their respective reserve currency. On the other hand, extensive money supply on the global economy, CBDC experiments, and governments not wanting to surrender their monopolies. As a result, some cryptocurrencies could remain as reserve currencies all around the world and securities would be best to classify most cryptocurrencies as CDBCs would be the most prominent cryptocurrency in a global economy. For cryptocurrencies to be reserve currencies, they should have scalability, liquidity, and the market cap of global currencies and governments wanting to give up on their monopoly on the money supply. As cryptocurrency market caps are far from supporting all the money supply, cryptocurrencies could only become a small fraction of reserve currency.