15 May 2021 · 5 min read

Imagine Bitcoin as a Reserve Asset. What Then?

It’s unlikely that any single country could gain a geopolitical advantage as a result of widespread BTC adoption by governments and central banks. Bitcoin could force central banks to manage their fiat currencies in a more responsible manner.

Source: Adobe/Krakenimages.com

Governments have finally sat up and taken notice of crypto. For years they derided, criticized, and even banned cryptocurrencies, but now they’re rushing to get in on the act, with numerous central banks planning to roll out their own digital currencies in the coming months and years.

As for real, decentralized cryptocurrencies, no government or central bank would currently dare admit to plans to buying up bitcoin (BTC) as a reserve asset. But if this happens, what it might mean on the international and local levels?

According to a variety of analysts, it’s unlikely that any single country — including China — could gain a geopolitical advantage as a result of widespread bitcoin adoption by governments and central banks. Instead, the expansion of bitcoin could have a number of knock-on effects on domestic politics, putting pressure on governments to more responsibly manage their own fiat currencies, and possibly even motivating them to nationalize their cryptocurrency mining sectors.

A theoretical threat

If bitcoin does ever become a reserve asset, the most obvious hypothetical concern that arises is that China — which still hosts most of the Bitcoin blockchain’s hashpower — somehow gains a considerable amount of political leverage over the rest of the world. In theory, it may be able to threaten to conduct a 51% attack that, say, reverses a payment (in BTC) made by a government to a nation or organization.

This is theoretically possible, but most analysts claim it’s highly unlikely.

“First, even though [mining] entities are located in China, they are different entities with different owners and probably different reasons for mining. They are also very large and have made a considerable capital investment in mining Bitcoin,” said Pete Earle, an economist with the American Institute for Economic Research.

Earle added that if China-based miners were convinced or cajoled into conducting a 51% attack, “they would immediately destroy much, if not all, of what they had invested in.”

He also noted that, even in a scenario where the Chinese government had nationalized or gained control of all mining facilities in the country, this still wouldn’t substantially increase the chances of an attack.

“If the Chinese government swept in, seized them all, and altered the consensus system […] that would likely trigger an utter collapse in the value, and thus price, of bitcoin. It’s an existential risk that must be considered by miners and Bitcoin holders alike.”

Other analysts largely agree with this appraisal. Also speaking to Cryptonews.com, Arcane Research’s Sofia Blikstad said it is unlikely that China could use mining to its geopolitical advantage.

“I don’t see a scenario where China can leverage mining. Miners tend to be more loyal to the network rather than the state; loyalty is guided by electricity prices and fees rather than political or geographic traits,” she said.

More practically, Lennix Lai — the director of financial markets at OKEx — suspects it wouldn’t even be possible for the Chinese state to pull off a 51% attack or anything similar for political purposes.

“Despite the fact that the majority of hash power comes from China, most of the mining field operators in the country are actually running cloud mining services — a type of proximity hosting that is ultimately contributed by end users instead of individuals or companies controlling the entire mining rigs. So the hash power in China is decentralized to an extent and it is practically impossible for any single party or even the government to seize control of any mining rig without alerting others,” he told Cryptonews.com.

This warning extends to any other government or state that may attempt to wield leverage over the Bitcoin blockchain. And with China’s dominance of hashpower declining (it dropped from 75% to 65% between September 2019 and April 2020), it’s also likely that, if and when bitcoin becomes a reserve asset, mining would be more dispersed and distributed by then.

“Even if this happens, most miners would take action against attackers within minutes to secure the network,” added Lai.

Risks & benefits

While it seems unlikely that any single nation will gain an advantage from bitcoin becoming a reserve asset (unless it buys up bitcoin early and becomes extraordinarily rich somewhere down the line), there would potentially be a range of other effects.

“Bitcoin could become sovereign collateral to back legal tenders like gold if that is the case. Hence, the mining business would possibly be nationalized. Owning and transacting bitcoin might become rather restrictive for the general public,” said Lai.

For Sofia Blikstad, bitcoin becoming a reserve asset or currency could exacerbate wealth inequality, something which would have domestic political implications.

“Placing BTC in Fed [US Federal Reserve System] reserves could send a dollar sell signal across the world. As bitcoin continues to gain in dominance, the less we want to hold fiat, hurting those whose material well-being depends on it, potentially fueling social division and populism,” she said.

On the other hand, Blikstad also suggested that bitcoin’s widespread adoption could have ramifications for monetary policy, insofar as reduced relative demand for US dollars (or any other fiat currency) will force it to compete to survive.

“So, I think the more likely scenario is Bitcoin acting as a catalyst to force central banks to manage their fiat currencies in a more responsible manner. Bitcoin may then help the central banks improve currency stability, as an incorruptible value standard,” she said.

But having said all this, analysts are actually skeptical that bitcoin will become a reserve asset/currency to the extent that every major central bank has a significant portion of it on their balance sheets.

As Pete Earle concluded,

“It seems unlikely that governments, and in particular central banks, will have any more interest in cryptocurrencies than they’ve had in gold over the last 50 to 100 years. It’s far more likely — as we’ve seen with the digital yuan — that they’ll adopt certain features of crypto design in a government or central bank digital currency while incorporating the ability to execute conventional and unconventional monetary policy actions.”

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