Bitcoin, a Top Contender for Global Reserve Currency

A reserve currency (also known as an anchor currency) is a foreign currency held in significant quantities by central banks or monetary authorities of several countries and is commonly used in international trade. The demand for reserves currencies is often higher as it is recognized and used to facilitate transactions in most nations around the world. Reserve currencies have the highest amount of circulation around the world.

Over the past few centuries, there has always been a currency or precious stone that dominates for some time. The dominant currency is issued by the economically dominant country. Studies show that the dominance of reserve currencies typically spans a century (100 years) before leaving the stage and marking the end of an era.

History of World Reserve Currencies

There have been six major world reserve currencies since the 1400s. Currencies such as the Portuguese Real, Spanish Real, Dutch Guilder or Florin, French Livre, British Sterling, and the US Dollar have served as reserve currencies at one point in the past 600 years.

Portuguese Real (1450-1530)

Portugal was the dominant economy during the Portuguese Colonial Empire. Originating at the beginning of the Age of Discovery, The Portuguese Empire was composed of overseas territories governed by Portugal. The power and influence of Portugal expanded across the globe during The Portuguese Empire; Portuguese sailors explored the Atlantic Coast of Africa and areas in East Asia, establishing ports and trade centers. During this period of economic dominance, the Portuguese real was recognized as a world reserve currency. The real, a silver-issued coin was first introduced around 1380 by King Fernando.

Spanish Peso (1530-1640)

The Spanish peso (also called real de a ocho or the Spanish dollar) was widely used between the 16th and 18th centuries as the currency of reference for world trade. This was the period of the rise of The Spanish Empire. The Spanish kingdom became united under King Ferdinand II of Aragon and Queen Isabella I of Castile. The king and queen reformed the Spanish monetary system and the real de a ocho became the standard monetary unit. The Spanish dollar was a standard silver coin that influenced the creation of other currencies. The US dollar was minted based on the model of the Spanish peso.

The US Dollar (1921-present)

The pound sterling, which was the world’s primary reserve currency in the 19th century saw a decline in dominance following the first and second world wars, in which the UK almost went bankrupt fighting the wars. By 1921, the US dollar (colloquially known as the greenback) had taken over as the world’s dominant currency.

During the period of the pound sterling’s adoption as the major reserve currency of the world, the gold standard was introduced. England adopted the gold standard in 1821; other countries and territories soon followed suit. In the gold standard, the value of monetary units was pegged to the value of gold.

The US was a major supplier of arms and weapons during the world wars. The US received most payments for its supply of arms in gold. By the end of the second world war, the US had amassed lots of gold. It became the country with the largest gold reserve in the world, controlling about two-thirds of the world’s gold. Other countries had depleted their gold reserves in funding the war; hence, the continuation of the gold standard became unfeasible.

World leaders soon realized the imminent need to establish a new international monetary system. In July 1944, 730 delegates from forty-four nations met at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire, to establish a new monetary system in which other currencies would be pegged to the US dollar instead of gold; and exchange rates could be determined between other currencies and the dollar, as the US dollar is backed by a significant gold reserve. The US also agreed to redeem US dollars for gold when demanded. The July 1944 agreement between nations is now known as the Bretton Woods Agreement.

In addition to the new monetary system, two new institutions were formed at Bretton Woods — the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (now known as the World Bank).

Bitcoin as a Potential Reserve Currency

The IMF released a paper titled: “The Stealth Erosion of Dollar Dominance: Active Diversifiers and the Rise of Nontraditional Reserve Currencies.” The paper studies the stealth decline of the US dollar as a reserve currency and other potential reserve currency replacements.

The IMF paper reveals that the decline in the US dollar’s dominance has not resulted in a shift towards the euro, the British pound, and the Japanese yen – also widely used in international trades along with the dollar and considered alternative reserve currencies. The paper shows that, interestingly, the shift from the dollar as a reserve currency has resulted in the gradual adoption of non-traditional reserve currencies. “This shift into nontraditional reserve currencies is substantial, and it is also broad based,” the paper states.

The IMF reveals that the share of non-traditional reserve currencies rose from negligible levels at the turn of the century to roughly $1.2 trillion and 10 percent of total identified reserves in 2021.

The IMF paper acknowledges that transaction costs have fallen with the advent of electronic trading platforms, automated market-making (AMM), and automated liquidity management (ALM) technologies for foreign exchange transactions; therefore, the usual cost savings associated with transacting in the US dollar — one of the main reasons the dollar is kept as a reserve — has diminished.

Sources: IMF Currency Composition of Official Foreign Exchange Reserves (COFER).

Central banks have also diversified their portfolios over the years, resulting in a shift from sticking to one reserve currency to exploring various traditional and non-traditional financial assets.

The IMF has been an ardent opposer to Bitcoin and cryptocurrencies in general. The monetary organization has been accused of being a tool of more powerful nations that enact policies that favor big economies at the expense of smaller, emerging economies. Its loans to countries with balance-of-payments deficits often come with unfavorable terms and conditions.

As blockchain technology is built on the core principles of decentralization and freedom, Bitcoin and other cryptocurrencies get excessive bad press from these international financial agencies. In the wake of El Salvador’s adoption of Bitcoin as a legal tender, the IMF released several statements severely criticizing the move made by the government of El Salvador.

In the “The Stealth Erosion of Dollar Dominance” paper, though the IMF mentions “non-traditional currencies” throughout the paper, it tactfully omits Bitcoin, cryptocurrencies, and blockchain technology.

Despite the bad press, the potential of Bitcoin to become a globally recognized and adopted reserve currency should not be underestimated.

Why Bitcoin Could Become a Global Reserve Currency

In the information age, technological advancements have disrupted many sectors in unbelievable ways. Decades ago, it would have been thought impossible to have a globally dominant car hire service such as Uber. The disruptions experienced so far in the transport, hospitality, and supply chain businesses, for example, are just the tip of the iceberg. With distributed ledger technology, disruption to the global finance ecosystem is around the corner.

True Financial Freedom

Several nations that were once colonies but have since gained independence still yearn for true financial independence — the type of independence only a decentralized asset like Bitcoin could provide. In several former French colonies, the common currency CFA franc is issued, controlled, and regulated by the French treasury. The CFA franc was formerly pegged to the French franc and later pegged to the euro, following France’s adoption of the euro. These former colonies maintain their foreign reserve in an “operating account” at the French treasury. Over the years, there has been significant “anti-CFA” outcry from citizens of these countries over the imposition of a currency and monetary system out of their control. The power of decentralization that cryptocurrencies like Bitcoin possess is a sure way to put an end to the traces of neocolonialism and monetary imperialism that still exists in parts of the world.

No Political Affiliation

Oftentimes, monetary policies by international financial bodies are politically motivated. Dissident nations are slammed with economy-crippling sanctions. A decentralized medium of exchange such as Bitcoin eliminates these politically motivated policies. Without a central authority, every party has a fair and equal say.

Speed, Immutability, Interconnectedness

The cost to transact on the distributed ledger system is significantly low. The scalability of Bitcoin has greatly improved through the introduction of second layers such as the Lightning Network; these improvements have further made Bitcoin a fast and even more reliable payment system.

Bitcoin as a reserve currency, and the advent of central bank digital currencies (CBDC), will create a global financial interconnectedness. Conversion between CBDC and reserve currencies will be instant, eliminating unnecessarily complicated procedures.

Takeaway

When blockchain technology and Bitcoin emerged a little over a decade ago, it would have seemed overly-optimistic to anticipate the level of adoption that cryptocurrencies have received. It might seem overambitious to consider Bitcoin a top contender for global reserve currency; as Bitcoin has proven since its inception, never underestimate its power and potential.

To learn more about Bitcoin, visit our Investing in Bitcoin guide.