Introduction
As of the first quarter of 2024, central banks collectively hold approximately $12.3 trillion in foreign exchange reserves, alongside an estimated $2.2 trillion in gold reserves. These reserves serve critical functions—facilitating international payments, stabilizing domestic currencies, servicing foreign currency debts, and cushioning economies against external shocks.
In recent years, a notable trend has emerged: central banks, particularly those in emerging economies, have been increasing their gold holdings. When accounting for unreported purchases acknowledged by industry insiders, official gold reserves surpassed the historic peak set in 1965 by the third quarter of 2023. Some nations may underreport their gold reserves to mitigate public criticism during periods of declining gold prices.
Amid this backdrop, a new candidate has entered the arena of reserve assets: Bitcoin. Thus far, El Salvador remains the only central bank to have openly declared Bitcoin as part of its sovereign reserves. As of August 2024, the country held 867 Bitcoin, valued at around $315 million, in addition to $3.1 billion in foreign exchange and gold reserves. Portfolio optimization studies suggest that an optimal allocation to Bitcoin in sovereign reserves may range between 2% and 5%. It is plausible that other nations have already begun incorporating Bitcoin into sovereign wealth funds, which operate under less stringent disclosure requirements than central bank reserves.
This article examines the rationale behind central banks’ growing interest in gold, as highlighted in the World Gold Council’s 2024 survey, and evaluates the extent to which these reasons might also justify holding Bitcoin as a reserve asset. We argue that Bitcoin shares certain characteristics with gold and may represent a viable reserve asset for some central banks, focusing particularly on its role as a store of value.
The Historical Context of Reserve Assets
Satoshi Nakamoto’s 2008 whitepaper introduced Bitcoin to the world, but its conceptual origins can be traced back to the Industrial Revolution. The advent of electricity transformed economic production, and today, electricity consumption is so integral to global output that researchers sometimes use satellite measurements of nighttime light intensity as a proxy for economic activity.
Traditional hard assets like gold require extensive physical labor for mining, refining, verification, and transfer. Gold’s divisibility and chemical durability allow it to be minted into standardized denominations, serving as a long-term store of value.
The Industrial Revolution introduced a new paradigm: the generation and verification of monetary value through electricity consumption rather than physical labor. Bitcoin embodies this shift—its mining process consumes electricity to generate new units and validate transactions.
A critical innovation of Bitcoin is its solution to counterfeiting, a persistent issue with physical gold. Bitcoin is self-verifying; the electricity used in mining also secures the public ledger that records all transactions. While any proof-of-work cryptocurrency could claim similar attributes, Bitcoin’s legitimacy stems from its originality—much as gold’s historical role as money distinguishes it from similar metals like platinum.
Performance During Economic Crises
A key attribute of any reserve asset is its ability to act as a hedge, providing positive returns when other assets falter. For instance, the U.S. dollar often appreciates during turmoil due to its “safe-haven” effect.
When measured by short-term volatility, Bitcoin exhibits significantly higher price swings than traditional reserve assets. Its performance during the initial phase of the COVID-19 pandemic was particularly poor, with prices dropping nearly 45% between March 6 and March 16, 2020.
However, no asset performs well under all types of economic stress. U.S. Treasuries, for example, are poor hedges against inflation. Bitcoin has demonstrated resilience during two specific types of crises: those involving U.S. bank failures and those triggered by large-scale financial sanctions. In these contexts, Bitcoin offers insurance benefits that other assets lack.
Store of Value and Inflation Hedge
Assessing Bitcoin’s long-term efficacy as an inflation hedge is challenging, as relationships between financial variables change over time. Even proven stores of value like gold can endure prolonged periods of low returns; from its January 1980 peak to its April 2001 trough, gold’s inflation-adjusted value fell by 86%. Over very long horizons—centuries—gold has maintained purchasing power. Historical data shows that the price of bread in terms of gold has remained relatively constant, and a Roman centurion’s salary (in gold) was roughly equivalent to that of a modern U.S. Army captain.
Bitcoin’s fixed supply—with new issuance halving approximately every four years—may offer inherent protection against inflation. Research indicates that changes in Bitcoin’s price often precede changes in expected inflation rates. Additionally, on a weekly basis, Bitcoin prices tend to rise alongside increases in online price indices.
Portfolio Diversification Benefits
For Bitcoin to serve as an effective portfolio diversifier, its returns should be driven by factors distinct from those affecting other reserve assets. Researchers at the Federal Reserve Bank of New York conducted an event study analyzing 30-minute windows around economic news announcements. They found that Bitcoin’s price was largely unresponsive to all macroeconomic news except inflation-related announcements. This contrasts with gold, which showed significant reactions to various economic news, suggesting that Bitcoin can provide diversification benefits in a gold-containing portfolio.
Leaving aside Bitcoin’s own volatility, the overall volatility of a reserve portfolio containing a small allocation to Bitcoin depends largely on its correlation with other assets. Prior to the COVID-19 pandemic, Bitcoin’s correlation with other reserve assets was near zero. Although this correlation rose during the pandemic, it has since declined from its peak in 2023.
The fact that Bitcoin’s performance is less tied to macroeconomic fundamentals than other financial assets indicates potential diversification benefits.
Absence of Default Risk
Bitcoin carries no default risk because it does not represent a claim on future cash flows, unlike bonds or stocks. Its security is cryptographically enforced through the mining process.
The concept of default is closely related to financial sanctions, which can be viewed as selective defaults preventing access to cash flows from sanctioned assets. The Bitcoin blockchain is inherently resistant to financial sanctions because miners are economically incentivized to process transactions. Even if some miners refuse to process transactions from a sanctioned address, the owner can offer higher transaction fees to incentivize other miners—potentially located in jurisdictions not enforcing the sanctions—to include the transaction.
While sanctions cannot prevent on-chain transactions, they may deter third parties from engaging with sanctioned entities. For example, U.S. sanctions against the crypto mixer Tornado Cash were largely effective not because they halted its operation, but because users feared legal consequences. Conversely, inflows to the Russian exchange Garantex increased after U.S. sanctions, as its promise to continue operating reassured some users.
Another form of default risk involves the custodians holding reserve assets. Many central banks use third-party custodians, such as the Federal Reserve Bank of New York, which may freeze assets under certain conditions. In 2023, the Central Bank of Venezuela lost a legal battle to unlock nearly $2 billion in gold stored at the Bank of England.
Bitcoin allows for self-custody, where the owner holds the keys authorizing blockchain transactions. This reduces reliance on third-party custodians but requires robust cybersecurity measures.
Thus, Bitcoin offers central banks potential sanctions evasion capabilities, especially if they have access to crypto trading infrastructure for converting Bitcoin into foreign currencies.
Liquidity Profile
While Bitcoin does not possess the deep liquidity of the U.S. Treasury market, its liquidity is sufficient to accommodate billion-dollar transactions, comparable to that of gold. In fact, Bitcoin may offer superior liquidity compared to some fiat assets subject to capital controls. Academic research shows that Bitcoin helps emerging economies circumvent capital controls; in Argentina, for example, cryptocurrency usage increased as capital controls tightened.
Role in Geopolitical Diversification
The International Monetary Fund has recently highlighted the potential impact of rising geopolitical tensions on international finance. Fragmentation of the global financial system could disrupt international capital flows, posing risks to financial stability, remittances, and trade.
Whether such fragmentation is actually occurring remains debated. A Federal Reserve economist examining 2022 international capital flows found no evidence that emerging market economies—including China, the Middle East, and India—were reducing their purchases of U.S. assets.
On the other hand, academic studies indicate that between 2016 and 2021, countries sourcing more military equipment from China and Russia also accelerated their gold reserve accumulation. In 2022, central banks purchased record amounts of gold, with notable buying from China, Turkey, India, and Middle Eastern oil exporters. Turkey’s strong demand for gold may be partly due to recent U.S. sanctions related to its military operations in Syria and its purchase of Russian air defense systems.
Regardless of the degree of geopolitical fragmentation, research provides evidence that Bitcoin can hedge geopolitical risk. Geopolitical risk predicts both Bitcoin returns and volatility. Among cryptocurrencies, only Bitcoin’s volatility correlates with fluctuations in the Geopolitical Risk Index, underscoring its unique status.
Frequently Asked Questions
Why are central banks considering Bitcoin as a reserve asset?
Central banks are exploring Bitcoin due to its potential as a diversification tool, its fixed supply offering inflation protection, and its ability to operate outside traditional financial systems, which may be advantageous in avoiding sanctions or capital controls.
How does Bitcoin compare to gold as a reserve asset?
Both assets share characteristics like scarcity and decentralization. However, Bitcoin offers advantages in transferability and verifiability, while gold has a longer historical track record and greater institutional acceptance. Each has unique risks and benefits.
What are the main risks of holding Bitcoin in reserves?
Key risks include high volatility, regulatory uncertainty, cybersecurity threats, and the evolving nature of crypto infrastructure. Central banks must carefully assess these factors before allocation.
Could Bitcoin replace the U.S. dollar in reserves?
It is highly unlikely that Bitcoin would replace the dollar entirely due to its volatility and scalability limitations. However, it could become a complementary asset in diversified reserve portfolios.
How can central banks securely custody Bitcoin?
Central banks could use self-custody solutions with robust multisignature arrangements and hardware security modules, or partner with regulated institutional custodians offering insurance and proven security practices.
Which countries are most likely to adopt Bitcoin first?
Nations facing high inflation, currency instability, or sanctions pressure may lead adoption. Smaller economies with more flexible policies could also experiment before larger central banks.
Conclusion
Neither Bitcoin nor gold is necessarily suitable for every central bank, and this article does not offer specific investment advice. Many factors influence reserve composition decisions, including alignment with currency pegs, import structures, and external debt obligations.
Bitcoin possesses unique investment characteristics that may help central banks diversify against various risks, including inflation, geopolitical tensions, capital controls, sovereign debt defaults, bank failures, and financial sanctions. To some extent, Bitcoin, like gold, can function as a reserve asset.
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*Source: The Bitcoin Policy Institute
Author: Matthew Ferranti (the US Intelligence Community)*