The Case for Bitcoin as a Reserve Asset

Dr. Matthew Ferranti of the Bitcoin Policy Institute (BPI) offers a number of reasons for why central banks might want to consider holding bitcoin as a reserve asset.

The Bitcoin Policy Institute (BPI) recently published a report titled "The Case for Bitcoin as a Reserve Asset," in which Dr. Matthew Ferranti discusses why central banks should consider adding bitcoin to their reserves. This follows a report by the European Central Bank (ECB), which claimed that bitcoin has no fair or intrinsic value and that its price appreciation is fueling division in society, a claim that was later disputed by experts.

Dr. Ferranti, who holds a PhD in Economics from Harvard University and served on the White House Council of Economic Advisers, begins the report by highlighting that central banks have been increasing their gold holdings and may want to consider adding bitcoin to their reserves, given that the two assets are "analogous in some respects." He also notes that only one central bank, the Central Bank of El Salvador, has officially disclosed adding bitcoin to its sovereign reserves, with bitcoin reportedly accounting for just under 10% of the bank's reserves, while an optimal bitcoin reserve allocation would be between 2% and 5%.

According to Dr. Ferranti, here are some reasons why central banks might want to keep some bitcoin on their balance sheets:

Performance During Crises

Dr. Ferranti argues in the report that "a key characteristic of a reserve asset is that the reserve asset provides a form of insurance by generating positive returns when other assets perform poorly." He adds that bitcoin has historically performed well during two types of economic crises: those related to large-scale US financial sanctions and those related to US bank failures.

Following both the failure of Silicon Valley Bank in 2023 and the imposition of US economic sanctions on Russia in 2022 due to the country's invasion of Ukraine, the value of bitcoin increased dramatically.

Long-Term Store Of Value

While bitcoin's value can be volatile to the downside in the short term, it tends to outpace many other assets over longer time horizons, due in part to its halving cycle, argues Dr. Ferranti.

Dr. Ferranti acknowledges that assets like bitcoin and gold can underperform for extended periods, but both assets perform well during inflationary periods. He also adds that a rise in bitcoin's price may actually predict an upcoming bout of inflation.

"Research suggests that changes in the price of bitcoin tend to predict changes in expected inflation," writes Dr. Ferranti.

Effective Portfolio Diversifier

Dr. Ferranti cites the Federal Reserve Bank of New York, which found that "the price of bitcoin is not correlated with any type of macroeconomic news except news related to inflation."

Because of this, Dr. Ferranti argues, bitcoin is an effective portfolio diversifier.

He argues that this is especially true given that bitcoin's correlation with traditional reserve assets (e.g., gold, foreign currencies) is low.

Lack Of Default Risk

Bitcoin does not carry default risk for three reasons, according to Dr. Ferranti. The first is that bitcoin, unlike stocks and bonds, does not represent a claim on future cash flows. The second is that the Bitcoin mining process cryptographically secures the network. And the third is that it's immune to financial sanctions, which are considered a form of "selective default." If a country custodies certain investment assets on behalf of a central bank and freezes access to those assets, like the way the Bank of England froze almost $2 billion of Venezuela's gold that it held in its custody, this is classified as selective default. Selective default cannot occur with bitcoin if a country takes custody of it, because bitcoin cannot be legally banned and can be used without permission.

Deep Liquidity

While bitcoin is not as liquid as the US Treasury market, which is the most liquid market in the world, it has become notably more liquid in recent years, with a market cap of over $1.3 billion.

Dr. Ferranti notes that "[bitcoin's] liquidity is sufficient to accommodate transactions in the billions of dollars, comparable to gold." While gold's market cap is still about 14 times that of bitcoin's, bitcoin is still quite liquid, at least much more so than a decade ago, when its market cap was a fraction of what it is now.

Central Banks Still Skeptical

Despite Dr. Ferranti's compelling arguments in his report, central banks remain skeptical about holding bitcoin.

However, it's worth noting that governments around the world, including those of Bhutan and Ethiopia, are mining bitcoin.

Will any of those Bitcoin mining profits be funneled into the coffers of those countries' central banks? It remains to be seen.

Perhaps some central banks are quietly acquiring bitcoin, while others may be considering the pros and cons of putting bitcoin on their balance sheets, as Dr. Ferranti suggests.

It's hard to imagine that some form of game theory won't come into play once one or two central banks announce that they've followed El Salvador's lead in holding bitcoin as a reserve asset, especially if one of