Facade on the Federal Reserve Building in Washington DC
In a recent report entitled “The Case for Bitcoin
Bitcoin
The report comes out on the heels of a report from the European Central Bank (ECB) in which the institution, which has claimed that bitcoin has no fair or intrinsic value, argued that Bitcoin’s price appreciation was fueling division in society, a claim that was later rebutted by experts.
Dr. Ferranti, who received his PhD in Economics at Harvard University and was a previous member of the White House Council of Economic Advisers, begins the report by noting that central banks have been expanding their gold holdings and that they might want to consider holding bitcoin, as well, since the two assets are “analogous in some respects.”
He also shared that only one central bank — the Central Bank of El Salvador — has publicly disclosed the addition of bitcoin to its sovereign reserves, highlighting that bitcoin makes up just under 10% of the bank’s reserves while an optimal bitcoin reserve allocation would range from 2% to 5%.
The following are some of the reasons why central banks might want to keep some bitcoin on their balance sheet, according to Dr. Ferranti.
Performance During Crises
Dr. Ferranti posited in the report that “a key characteristic of a reserve asset is that the reserve asset provides a form of insurance by producing positive returns when other assets perform poorly.”
He added 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.
In the wake of both Silicon Valley Bank failing in 2023 and the US placing economic sanctions on Russia due to the country’s invasion of Ukraine in 2022, bitcoin’s price dramatically increased in value.
Long-Term Store Of Value
While bitcoin’s value can be volatile to the downside in the short-term, it tends to outperform many other assets over longer time horizons, which is, in part, due to its halving cycle, argued Dr. Ferranti.
Dr. Ferranti acknowledged that assets like bitcoin and gold can underperform for extended periods of time, but that both assets perform well during inflationary periods. He also shared that a rise in bitcoin’s price may actually forecast an oncoming inflationary bout.
“Research suggests that changes in the price of bitcoin tend to predict changes in expected inflation,” wrote Dr. Ferranti.
Effective Portfolio Diversifier
Dr. Ferranti cited the Federal Reserve Bank of New York, which found that “the price of bitcoin is unrelated to all types of macroeconomic news except news related to inflation.”
Because of this, Dr. Ferranti claims, bitcoin is an effective portfolio diversifier.
He argues that this is particularly true in that bitcoin’s correlation with traditional reserve assets (e.g., gold, foreign currencies) is low.
Lack Of Default Risk
Bitcoin doesn’t have default risk for three reasons, according to Dr. Ferranti.
The first is that bitcoin doesn’t represent a claim on future cash flows like stocks and bonds do.
The second is that the Bitcoin mining process cryptographically secures the network.
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 can’t happen with bitcoin if a country takes custody of it, because bitcoin can’t technically be banned and can be used permissionlessly.
Deep Liquidity
While bitcoin isn’t as liquid as the US Treasury market — the most liquid market in the world — it has become notably more liquid in recent years, as its market cap currently sits at over $1.3 billion.
Dr. Ferranti shares that “[bitcoin’s] liquidity is sufficient to accommodate transactions in the billions of dollars, comparable to gold.”
While gold’s market cap is still approximately 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
While Dr. Ferranti makes compelling arguments in his report, central banks remain skeptical of holding bitcoin.
With that said, it’s important to note that bitcoin is being mined by governments around the world, including those of Bhutan and Ethiopia.
Will some of those Bitcoin mining profits be transferred to the coffers of the central banks of those countries? This remains to be seen.
Maybe some central banks are quietly acquiring bitcoin, while others might be listening to the likes of Dr. Ferranti, contemplating the pros and cons of putting bitcoin on the balance sheet.
It’s hard to imagine that some form of game theory won’t play out when one or two central banks come forward to say they’ve followed El Salvador’s lead in holding bitcoin as a reserve asset, especially if one of those countries is the United States, where a bill has been introduced to create a strategic bitcoin reserve.
Disclosure: I am an employee Bitcoin Magazine, which is a company owned by BTC Inc. BTC Inc used to be one of the primary funders of the Bitcoin Policy Institute (BPI).