Cryptocurrency: reserve currency or not? | Author Ata Tekeli | The Capital | July 2021


Complex issues that can have a huge impact on the global economy.

Since Bitcoin (BTC) entered the market, many cryptocurrency enthusiasts believe that Bitcoin is the best alternative to reserve currencies. Especially when we consider the catastrophic effects of unlimited money printing, Bitcoin and various cryptocurrencies can be used to protect the value of local currencies. Here, we will look at whether cryptocurrency can become a reserve currency, and what kind of cryptocurrency can become a central bank’s reserve currency.

Before we get into the topic, let’s discuss the definition of currency and reserve currency.

So, what is money?

Currency can be defined as a medium of exchange, a store of value, a unit of account, and a policy tool. In other words, money is used to pay for goods and services, to save money for rainy days, and a stable place to store it.

So, what is a reserve currency?

Reserve currencies are large amounts of currencies held by central banks and other financial institutions to prepare for investment, transactions, and international debt obligations, or to affect domestic exchange rates. Reserve currencies affect the prices of most commodities, and many institutions will have to hold reserve currencies to pay for these commodities in order to use them for production.

What are the characteristics of reserve currencies?

-The currency risk associated with the economic environment is minimal

-A liquid and widely accepted medium of exchange around the world

-Reliability for global affairs

-Have network externalities on a global scale

-Low-risk assets that are easy to trade

Before the U.S. government became legal tender, what was the reserve currency?

Throughout history, various commodities have been used as reserves in various countries. However, sovereign states use gold, silver, bronze, copper, nickel and other valuable items as some kind of reserve currency to support the local economy. Now, let’s take a look at various commodities:

Gold

Throughout history, sovereign nations have used gold for various reasons to stabilize their economies. First of all, gold is a rare earth metal, which is difficult to extract. Therefore, it has great value, and sovereign states can generate valuable currencies to influence local and international markets. Secondly, the value of gold is relatively stable, with only deflationary characteristics, it is difficult to extract and put on the market. Therefore, sovereign states and wealthy nobles can accumulate wealth and have sufficient reserves to support their payments when needed.

silver

Although gold is the most commonly used currency reserve, the government still uses silver to a certain extent. The use of silver can be used to produce a currency inferior to silver, mixed with the main currency, so that the country’s main currency can be issued to the market more or purely as a reliable reserve currency. Although some civilizations completely use silver as a reserve currency, because silver is mined more than gold, most countries prefer to use silver to devalue their national currency when it is difficult to manage budgets and economies. This can be described from the economic difficulties of the Roman Empire and the Ottoman Empire.

bronze

Bronze is the most abundant resource because it is relatively easy to produce from copper. This has led countries to create bronze coins as the most inferior currency, because bronze is the most common medium of exchange in most jurisdictions, and the government will specify the exchange rate value of silver and gold. Similar to silver, if the government has problems related to currency demand and balance of payments, bronze can be used to devalue a country’s main currency.

How to withdraw commodities from the currency?

Before the U.S. government abolished gold as the main reserve of the U.S. dollar (USD), the printing of money would be linked to the total market value of gold. But when the U.S. government had problems with its balance of payments since the 1960s due to the Vietnam War and welfare programs, the U.S. government had to abandon its gold reserves to deal with the balance of payments deficit. When the government realized the problem with the dollar, the government began to sell dollars and fully convert its dollar reserves into gold. Therefore, the U.S. government had to remove gold from the U.S. dollar and make it a widely used currency so that the U.S. government could control the global money supply and make up the budget deficit.

Cryptocurrency as a reserve currency

Since the listing of Bitcoin, many enthusiasts have suggested that some cryptocurrencies can be used as reserve currencies to balance the consumption habits of most financial institutions. Although Bitcoin was initially proposed as a reserve currency, Ethereum (ETH) and Binance Coin (BNB) have also become popular reserve currency choices because they have been proven in the blockchain field.

Why do some people recommend the use of well-known cryptocurrencies as reserve currencies?

In reserve currencies, the government can only generate currency in proportion to the market value of a certain commodity. Since primary reserves are often difficult to extract and market, primary currencies become valuable due to scarcity. When looking at Bitcoin, because it is extracted through mining and block rewards decrease over time, the scarcity factor plays an important role in the currency, limiting the local currency supply and increasing value. On Ethereum, before the introduction of Ethereum 2.0, mining was the only option. The advantage of Ethereum is that it is one of the most difficult to withdraw cryptocurrencies, even for staking. To pledge Ethereum on the contract address, the wallet needs at least 32 Ether to lock the contract address, and there is a vesting period and an annual rate of return to keep the value. In short, cryptocurrency can be used to support local currencies and protect the value of the currency from financial and economic shocks.

What is the way for cryptocurrency to become a reserve currency?

-There is too much money supply in the global economy,

-The government’s monopoly on money,

-Central Bank Digital Currency (CBDC) government experiment

-Scalability issues, because Ethereum can support 15 transactions per second, while Bitcoin only supports 7 transactions per second. More importantly, Ethereum has the highest transaction fees. However, Ethereum can reverse the situation through Ethereum 2.0, which has a fee structure and scalability.

Concluding remarks

Although El Salvador accepts Bitcoin as a reserve currency, and some countries consider using Bitcoin as a reserve currency to reduce the impact of economic wars. In this plan, governments with a very limited money supply can use Bitcoin to increase the value of their currency in the global market. However, the government can only print currencies that are equivalent to the market value of their respective reserve currencies. On the other hand, the massive money supply in the global economy, CBDC experiments, and the government does not want to give up monopoly. Therefore, some cryptocurrencies may continue to serve as reserve currencies around the world, and it is best for securities to classify most cryptocurrencies as CDBC, which will become the most prominent cryptocurrency in the global economy. For cryptocurrencies to become reserve currencies, they should have scalability, liquidity, and the market value of global currencies, as well as governments that want to abandon their monopoly on money supply. Since the market value of cryptocurrencies is far from supporting all the money supply, cryptocurrencies can only become a small part of the reserve currency.

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