Global Central Bankfollow! Does BTC have too high potential to become a new global reserve asset?

Central Bank studies the impact of BTC, monetary policy faces challenges

In recent years, many Central Banks and Financial Institutions around the world have conducted research on BTC and its potential impact on monetary policy. Research conducted by organizations such as the Federal Reserve Bank of Minneapolis, the European Central Bank (ECB), and the International Monetary Fund (IMF) emphasizes that the disruptive nature of cryptocurrencies like BTC may limit the ability of Central Banks to perform traditional economic management functions. Supporters have always believed that BTC could be an alternative solution for Central Banks; now, are Central Banks finally recognizing the existence of BTC as a potential threat?

The European Central Bank has issued two research reports on BTC at different times, with different views. The first one was published after the collapse of FTX in 2022, when the price of BTC fell to about $16,000, titled 'The Last Stop of BTC', describing BTC as a failed currency experiment. However, by 2024, with the price of BTC approaching $70,000, the same group of authors from the European Central Bank published another report titled 'The Distributive Consequences of BTC', acknowledging a different reality.

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The wealth distribution effect of BTC has triggered the Central Bank follow

A recent report suggests that the existence and continuous appreciation of BTC have had a significant impact on wealth distribution. As the price of BTC rises, early holders become wealthier. However, since BTC itself does not produce anything or increase economic output, this increase in wealth and consumption must necessarily come directly from the reduction in consumption by other members of society. In other words, when early holders spend their profits, they are actually using purchasing power that has been transferred from those who have never owned BTC or purchased it later. This reduction in purchasing power, even in the case of a continuous rise in BTC prices, will also affect those who have never purchased BTC.

The key insight of the report is that the wealth of BTC does not create new economic value, but only redistributes existing wealth. The author believes that this is different from the growth of stock or real estate value, which can reflect and promote the improvement of actual economic productivity and output. The returns of BTC are purely redistributive, as BTC itself does not produce anything or increase economic capacity.

This perspective reflects the BTC supporters' long-standing criticism of the Central Bank. According to the 'Cantillon Effect' proposed by Richard Cantillon, an economist in the 18th century, the Central Bank, through printing money, excessively enriches the people closest to the money supply, such as banks and the wealthy, while others face a decrease in purchasing power. When new money enters the economy, not all prices are affected at the same time. Those who receive the new money first (usually Financial Institutions) can spend these funds before prices rise, while those furthest from the money supply (usually ordinary citizens) can only experience the resulting inflation.

Image source: River "Cantillon Effect" (The Cantillon Effect) diagram

BTC's challenge to monetary policy has sparked longer discussions

A recent working paper from the Minneapolis Federal Reserve Bank explores BTC from various perspectives. The report suggests that the ability of governments to sustain budget deficits will become more difficult when people are free to buy and hold BTC. Typically, governments can spend more than tax revenues by selling government bonds. However, when BTC exists as an alternative, governments may be forced to only spend the taxes they collect.

Researchers have found that the only way to solve this problem is to completely ban Bitcoin, or to impose specific taxes on BTC holders.

In its 2023 policy report, the IMF also expressed concern about BTC's potential to weaken the effectiveness of monetary policy, especially in emerging markets with unstable currencies and weak monetary frameworks. The IMF recommends that countries first strengthen their monetary policy frameworks and institutions rather than implementing a comprehensive BTC ban. The report points out that Stable Coins linked to foreign currencies are more likely to lead to the "encryption" phenomenon compared to cryptocurrencies with greater volatility. The IMF specifically recommends against granting legal tender status to encrypted assets, so as not to further weaken monetary sovereignty. The IMF advocates that the solution lies in strengthening traditional monetary and fiscal frameworks rather than just focusing on restricting cryptocurrencies.

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The change in the Central Bank's attitude towards Bitcoin may make it a reserve asset in the future.

The previous reports from the Central Bank and IMF both indicate that the monetary legislative institutions are taking a more serious attitude towards BTC than before. Although the working reports may not fully reflect the thinking of the decision-makers at the Central Bank, they show that monetary policy is increasingly taking BTC seriously. This change in attitude is not only reflected in academic reports, but also in policies. For example, the IMF included multiple anti-cryptocurrency clauses in the bail-out plan for Argentina in 2022.

It is worth noting that the criticism of BTC by the European Central Bank has also triggered self-reflection within the Central Bank itself. If the redistribution effect of BTC is seen as a problem, then what is the difference if monetary policy redistributes purchasing power from those farthest from the money supply to those closest to it through the adjustment of currency supply? Both mechanisms seem to create winners and losers through the redistribution of purchasing power, rather than through productive economic activities. In any case, if the adoption of BTC increases and poses obstacles for the Central Bank in formulating monetary policy, it should not come as a surprise to the Central Bank. After all, since the birth of BTC, its self-proclaimed goal has been to provide an alternative solution for central planning monetary policy.

Experts suggest Central Bank consider BTC as a reserve asset

The BTC Policy Institute (BPI) recently released a report titled 'Reasons for BTC as a Reserve Asset', written by Dr. Matthew Ferranti, an economist. He put forward multiple reasons for Central Banks to consider BTC as a reserve asset. Ferranti pointed out that Central Banks have been increasing their gold holdings and may also consider holding BTC as they have similarities in certain aspects.

He emphasized that BTC has performed well during economic crises, especially in the case of financial sanctions and bank failures in the United States. For example, after the collapse of Silicon Valley Bank in 2023 and the US imposing economic sanctions on Russia in 2022, the price of BTC saw significant increases. In addition, although BTC has experienced significant fluctuations in the short term, its long-term performance is superior to many other assets, and its correlation with traditional reserve assets is low, making it an effective investment diversification tool.

Image source: BPI BTC performed well when Silicon Valley Bank collapsed (left) and the United States sanctioned Russia (right)

However, the Central Bank remains cautious about holding BTC. Currently, the only Central Bank that has publicly announced the inclusion of BTC in its sovereign reserves is the Central Bank of El Salvador. However, as the influence of BTC continues to grow globally, perhaps some Central Banks are quietly accumulating BTC and considering including it in their balance sheets. Once more Central Banks follow in the footsteps of El Salvador and use BTC as a reserve asset, there may be significant changes in the global financial landscape.

Image source: Bitcoin Office El Salvador BTC reserves

[Disclaimer] There are risks in the market, and investment should be cautious. This article does not constitute investment advice. Users should consider whether any opinions, viewpoints, or conclusions in this article are in line with their specific circumstances. Invest at your own risk.