Central Banks Have Turned to Buying Bitcoin
In recent years, we have witnessed significant changes in the financial world, one of the most important being the emergence of digital currencies such as Bitcoin. Central banks, traditionally known as the institutions safeguarding and stabilizing financial systems, now seem to be considering the purchase and accumulation of Bitcoin. While this decision might seem odd at first glance, it could, in fact, be a sign of profound shifts in the outlook and approach of these institutions toward digital currencies. In this report, we examine the reasons behind and potential impacts of central banks’ growing interest in buying Bitcoin.
Table of Contents
The Emergence of Connections Between Digital Currencies and Central Banks
After Facebook unveiled the “Libra” project in 2019, the cryptocurrency industry caught the attention of central banks. As a result, many of them sought to create and expand new digital currencies. Cryptocurrencies like Bitcoin and Ethereum are digital currencies that use blockchain technology and cryptography to create and manage transactions. These currencies were created in response to the 2008 financial crisis, while Central Bank Digital Currencies (CBDCs) are digital versions of a country’s fiat currency, issued as part of the official monetary system in response to the rise of controlled cryptocurrencies.
Currently, over 90% of central banks around the world are working on CBDCs, which indicates their interest in blockchain technology. It is useful to compare the differences between cryptocurrencies and central bank digital currencies.
The Difference Between Cryptocurrencies and Central Bank Digital Currencies
1. Control and Supervision:
Cryptocurrencies: These are decentralized and not controlled by any central authority.
Central Bank Digital Currencies: These are issued and controlled by a country’s central bank and are recognized as legal tender.
2. Underlying Technology:
Cryptocurrencies: typically use public blockchain technology, which is managed by a network of users.
Central Bank Digital Currencies: Use permissioned blockchains or centralized systems.
3. Participants:
Cryptocurrencies: Anyone can participate in the network without permission.
Central Bank Digital Currencies: The central authority decides who can participate in managing the system.
4. Value and Backing:
Cryptocurrencies: These are highly volatile, and their value is determined by supply and demand in the open market.
Central Bank Digital Currencies: These are supported by the central bank and, their value is fixed like fiat money.
5. Purpose:
Cryptocurrencies: Often used for investment and decentralized financial transactions.
Central Bank Digital Currencies: Designed to improve payment systems and increase the efficiency of the financial system.
6. Transparency and Privacy:
Cryptocurrencies: Generally offer more transparency but are semi-anonymous, meaning users’ identities are not directly revealed.
Central Bank Digital Currencies: Due to the centralized system, the central bank may have more access to financial transactions, potentially limiting user privacy.
Bitcoin: The New Star in Central Bank Asset Portfolios!
Central banks are generally cautious about digital currencies, especially Bitcoin. This caution stems from Bitcoin’s decentralized nature and price volatility, which conflict with the traditional monetary policies of central banks. Additionally, concerns about regulatory uncertainty and lower liquidity compared to major currencies are other reasons for this caution. Some of these concerns are detailed in the table below.
Some Reasons for Central Banks’ Caution in Buying and Holding Bitcoin
| Reason | Explanation |
|---|---|
| Price Volatility | The price of Bitcoin is highly volatile and can increase or decrease significantly within a short period. This volatility presents a significant risk for central banks, which seek stability in their reserves. |
| Uncertainty in Regulation | Bitcoin operates completely outside traditional financial systems and regulatory frameworks. This creates concerns regarding legal risks and the consequences of holding a decentralized digital currency for central banks. |
| Liquidity Concerns | The liquidity of the Bitcoin market is still lower compared to major currencies. Central banks require assets with high liquidity to effectively manage monetary policies and quickly liquidate assets if necessary. |
| Concerns About Store of Value | Central banks are developing their own digital currencies as a replacement for cryptocurrencies like Bitcoin. Central bank digital currencies aim to offer the benefits of digital currencies within a framework regulated by central banks, thereby reducing concerns about volatility, lack of regulation, and liquidity. |
| Alternative Technologies | Central banks are developing their own digital currencies as a replacement for cryptocurrencies like Bitcoin. Central bank digital currencies aim to offer the benefits of digital currencies within a framework regulated by central banks, thus reducing concerns about volatility, lack of regulation, and liquidity. |
Despite this, on July 3, 2024, Guy Turner, the host of the popular YouTube channel Coin Bureau, published a video in which he mentioned the possibility of central banks purchasing Bitcoin. He examined the potential impact of this development on the market.
Turner referred to El Salvador’s decision in 2021 to begin accumulating Bitcoin, speculating that central banks around the world might soon follow this pattern, claiming that some countries are already secretly doing so. He emphasized the importance of understanding the relationship between cryptocurrencies and central banks in order to comprehend potential future developments.
Why Central Banks Might Lean Towards Holding Bitcoin: A Deeper Analysis
In the world of economics, the growing trend of central banks purchasing and accumulating Bitcoin, which once seemed unimaginable, is now becoming a tangible reality, raising numerous questions in the minds of experts, investors, and ordinary people.
Several reasons exist for this new trend:
1. Hedge Against Inflation:
Controlling inflation is a perennial challenge for central banks. Raising and lowering interest rates are their primary tools for this purpose. However, these tools have their own disadvantages. Lower interest rates mean cheaper borrowing, leading to higher purchasing power and less saving. On the other hand, higher interest rates mean more expensive borrowing, reducing purchasing power and causing more people to save cash. As easy as printing fiat money (paper money) is, removing it from circulation is a very difficult task.
In fact, this is one of the reasons central bank digital currencies (CBDCs) were created. They can actively control inflation by removing tokens at specific times, similar to burning tokens in certain cryptocurrencies.
Bitcoin, as an asset with lower inflation rates, can act as a hedge against inflation. Its decentralized nature and limited supply naturally control its inflation, in contrast to fiat currencies printed by governments.
2. A Replacement for Gold Reserves:
Bitcoin, due to its unique characteristics mentioned below, has been recognized by many investors as “digital gold” and can serve as a substitute for physical gold reserves.
Storing Bitcoin as “digital gold” helps strengthen the base currencies of central banks. This is especially important for countries that currently do not have enough gold reserves to back their currencies.
3. Decentralized Nature:
Over time, people have increasingly realized that if all money is controlled by one large financial institution, the world will head toward destruction. This has led to more individuals seeking alternatives to the current financial system, with Bitcoin standing as a formidable competitor. In order not to fall behind, central banks may want to accumulate some Bitcoin as a precautionary measure. Interestingly, this is exactly what “Fidelity,” one of the world’s largest asset managers, had predicted would happen in 2022.
A key feature of Bitcoin is its decentralized nature. This means Bitcoin is not controlled by any entity or government and is immune to removal, confiscation, or manipulation. In a world increasingly dependent on centralized financial systems, this feature makes Bitcoin attractive to central banks seeking to diversify their reserves and reduce dependence on the US dollar.
Countries under economic sanctions can use Bitcoin for international transactions without relying on traditional financial systems. This is why some countries have started using it for their international transactions.
4. Growing Concerns About Global Economic and Financial Stability:
Central banks in various countries, in the face of economic uncertainties and financial crises, are looking for ways to protect their reserves and reduce the risks posed by sudden market changes. Bitcoin, as a decentralized digital asset with a limited supply, can act as a safe haven against market fluctuations and the devaluation of national currencies.
5. Rising Acceptance and Use of Bitcoin:
As Bitcoin becomes more widely accepted and used in transactions and currency reserves, central banks’ willingness to purchase and accumulate it also increases, forming part of these banks’ strategy in preparation for future developments.
Conditions Required for Central Banks to Use Bitcoin
BIS Standards (Bank for International Settlements):
The international body overseeing central banks is developing standards for holding digital currencies on banks’ balance sheets. These standards aim to create a framework for managing risks and ensuring financial system stability.
Market Liquidity:
The cryptocurrency market must have sufficient liquidity for central banks to conduct large-scale transactions without affecting prices. The increased inflow of capital into US-based Bitcoin ETFs is an effective step toward enhancing liquidity in this market.
Privacy:
Central banks need privacy for their transactions. Various solutions, such as the use of private wallets or private-chain transactions, can meet this need by ensuring that purchases and transfers are untraceable.
Secure Storage:
Bitcoin must be securely stored to prevent hacking or theft. Using “cold storage” (which is an offline wallet designed to securely store private keys) is an efficient and safe way to store Bitcoin on a large scale.
Regulation:
As long as Bitcoin accumulation is not legally recognized, central banks are unlikely to enter this market. This is understandable, as the risks of doing so currently outweigh the benefits.
The BIS, one of Bitcoin’s strongest critics, believes that “cryptocurrencies are not stable or reliable enough to become money.” The International Monetary Fund (IMF), another institution, does not approve of cryptocurrency markets. In fact, it is so opposed to the idea that it has suggested using CBDCs to combat the adoption of digital currencies. Meanwhile, some central banks have already started accumulating Bitcoin behind closed doors. Most cryptocurrency market analysts believe we will see the peak of the current market rise in 2025. The question now is: do you really think central banks will wait for the market’s peak to start their involvement?
Central banks are looking for ways to diversify their assets, and Bitcoin presents an attractive option for them.
-Bill Ackman, American investor and founder of Pershing Square Capital Management
Potential Market Impacts
Positive Effects:
Impact on Bitcoin Price:
The injection of billions of dollars from central banks into the Bitcoin market would significantly increase demand and drive the price higher. This is similar to how central bank demand has impacted gold prices. Over the past 20 years, despite rising interest rates (which would typically negatively impact gold prices), the recent surge in central bank demand for gold, surpassing 1000 tons per year, has driven its price to historic highs of $2450 per ounce. This is related to several factors, including inflation and fear of US sanctions.
Of course, this hypothesis holds if Bitcoin is considered a secure and valuable asset like gold. In that case, central banks, by purchasing during price dips, would play a significant role in its price determination. This could increase short-term price volatility.
Attraction of New Investors:
Central banks buying Bitcoin would boost trust in the digital currency and attract new investors. Bitcoin’s superior performance compared to gold in recent years increases this interest, and central bank actions might even lead traditional investors, who are committed to assets like gold, to shift toward Bitcoin.
Changes in Monetary Systems:
The use of Bitcoin by central banks could lead to changes in traditional monetary systems.
Increased Competition:
The entry of central banks into the cryptocurrency market could intensify competition and lead to new, innovative services being offered by companies active in this field.
Negative Effects:
1. Sudden Decline in Demand:
The massive demand for Bitcoin driven by central banks could also increase the risk of sudden demand drops. This could happen for various reasons, including:
Changes in Central Bank Policies:
If inflation is brought under control and the need for liquidity injection into the economy decreases, central banks might stop purchasing Bitcoin or even sell their holdings.
Economic Crises:
In a crisis, central banks might seek quick liquidity and sell their assets, including Bitcoin, quickly.
Increased Regulatory Risks:
In a scenario of centralized regulation, both institutional and retail investors might avoid investing in Bitcoin, leading to reduced demand for the digital currency. For example, in 2017, after Bitcoin’s price skyrocketed, Chinese authorities banned cryptocurrency exchanges, causing Bitcoin demand to plummet and its price to fall sharply.
2. Tightening Regulations:
Negative experiences, like the collapse of the FTX exchange, where billions of dollars of investors’ capital were lost, could push central banks toward implementing stricter regulations in the crypto market. These regulations might include:
Restrictions on Bitcoin trading by banks and investors;
Increased regulatory requirements for cryptocurrency exchanges and platforms;
Banning certain cryptocurrency-related activities in specific areas.
For example, in 2021, after rising concerns over the risks of stablecoins, US authorities asked Facebook to halt its Diem stablecoin project.
Increased Bitcoin Instability:
Central bank money printing to purchase Bitcoin could increase liquidity and cause further instability in Bitcoin’s price. This could happen for two reasons:
Increased Bitcoin Supply: Central banks printing money to buy Bitcoin means more Bitcoin is circulating. This could exert downward pressure on Bitcoin’s price.
Changes in Investor Behavior: When central banks are actively purchasing Bitcoin, retail investors may look for quick profits and engage in short-term trading. This could cause further market instability.
For example, in 2020, after the Federal Reserve announced unprecedented money printing to counteract the economic impacts of the coronavirus, Bitcoin’s price rose significantly. However, this price increase was not sustainable, and Bitcoin experienced considerable volatility in the following months.
4. Central Bank Domination:
Mass purchasing of Bitcoin by central banks would increase their power and influence in the cryptocurrency market. This could increase centralization within the Bitcoin network, changing its decentralized nature.
Bitcoin, as a secure and decentralized digital asset, can serve as a store of value.
-Anthony Pompliano, entrepreneur and cryptocurrency investor
Other Digital Currencies of Interest to Central Banks: Potential Options
In addition to Bitcoin, central banks may also pay attention to other digital currencies:
Digital currencies similar to Bitcoin:
Such as Litecoin (Litecoin) or Bitcoin Cash (Bitcoin Cash), which have similar features to Bitcoin.
CBDC-related projects:
Such as Stellar (Stellar), Ripple (XRP), or projects used by central banks to develop their own CBDCs.
Tokenized gold:
Such as PAX Gold or Tether Gold, which offer benefits like easier transport and cheaper storage compared to physical gold.
Ethereum: The closest competitor to BTC due to its high market value, the existence of approved but still unlisted spot ETFs, proof-of-stake consensus, and strong infrastructure.
Current Opponents and Supporters of Bitcoin Accumulation
While some central banks like the European Central Bank (ECB) and China oppose Bitcoin purchases and are seeking to implement strict regulations on cryptocurrencies, others, such as the Swiss National Bank and Russia, have a favorable view towards holding BTC in order to reduce dependence on the U.S. dollar and facilitate international transactions. India, due to concerns about the negative impacts on financial stability and preventing illegal use, has adopted an uncertain stance on this issue.
Currently, some countries are working on regulations for the use of digital currencies. For example, Japan is trying to control and monitor Bitcoin transactions by registering cryptocurrency exchanges and issuing financial directives. In China, despite rumors of a complete ban, Bitcoin trading continues, albeit with restrictions.
Central banks are currently focusing more on developing central bank digital currencies (CBDCs) than on purchasing and accumulating Bitcoin. This approach allows them to have greater control over the financial system.
Bitcoin is the first example of a new kind of life that breathes and lives on the internet. It cannot be changed, and it cannot be resisted. It cannot be corrupted or bribed. If a nuclear bomb wipes out half the world, Bitcoin will continue to live.
— Ralph Merkle, American computer scientist, cryptographer, and inventor of Merkle tree structure.
Final Thoughts
The purchase of Bitcoin by central banks could have widespread effects on the digital currency market and financial systems. From increasing demand and prices to enhancing credibility and oversight, this decision could help form a more stable and credible market for Bitcoin.
Sources:
https://www.rba.gov.au/education/resources/explainers/cryptocurrencies.html
https://www.edps.europa.eu/system/files/2023-03/23-03-29_techdispatch_cbdc_en.pdf
https://protos.com/are-central-banks-really-buying-bitcoin-1
https://www.mitrade.com/insights/news/live-news/article-3-215262-20240617
https://www.binance.com/en/square/post/10495887919289
https://www.investopedia.com/articles/investing/050715/can-bitcoin-kill-central-banks.asp
