Cryptocurrency as Foreign Reserves?

The World Bank's white paper on cryptos' role in foreign reserve portfolios argues "Not Today, and Likely Not in the Near Future."

The increasing market capitalisation, footprint, and structure of crypto-assets have prompted institutional investors, such as central banks, to investigate potential exposures to these assets and determine if it is fair to include them in their portfolios.

While crypto-assets might play a role in central banks' reserve portfolios in the future, the World Bank authors state that these instruments do not qualify at the moment in their current state.

Even though there has been some guidance from policy makers and standard-setting bodies, the regulatory landscape for crypto-assets is still unclear, and their value is very volatile, which makes them unreliable as a store of value.

Open, decentralised computer networks are the usual operating environment for crypto-assets.

An irreversible distributed ledger is the goal of many decentralised networks; this would allow users to hold funds with global reach and reasonably rapid settlement in a peer-to-peer way, thereby eliminating the need for intermediaries and the risk of third-party meddling.

To qualify as instruments for reserve portfolios, crypto-assets must undergo certain fundamental modifications.

What Is the World Bank's Take?

1) Decreased Volatility Needed: Crypto assets are not a good way for central banks to self-insure against shocks because their prices are highly volatile, with an annualised volatility of 70%. This is far greater than the volatility of equities and gold.

2) Stronger Custody & Safekeeping Solutions: The loss or theft of cryptographic private keys, which are essential to crypto assets like bearer instruments, might result in the irretrievable loss of monies.

Essential for storage, access & authentication are industry-grade solutions for managing and executing private keys that can resist fraud or cyber-attacks.

3) More Than Enough Decentralisation: Potential dangers exist in crypto-asset initiatives that are not adequately decentralised and hence subject to substantial control by a governing body or central party.

Large investors are hesitant to take on and manage substantial exposures to crypto-assets due to their limited liquidity and market capitalisation compared to more traditional currencies and asset classes.

However, derivatives markets have developed to control risks, and the liquidity of the biggest crypto-assets (such as Bitcoin and Ether) has greatly increased.

4) Investment Tools Are Readily Available: Government bonds and other extremely safe investments are the norm for central banks.

For the most part, crypto-assets don't perform anything useful on their own, like generate interest or dividends.

Despite the potential for "staking" to create revenue and the potential for DeFi apps to aid in the generation of returns on crypto assets, there are still many unknowns and dangers in this experimental environment.

5) Implementation of Banking & Commerce Protocols: If reserve managers want to protect themselves against trade and financial shocks, they must get exposure to crypto-assets, which means using them for (cross-border) investment and trade flows.

In such flows, cryptoasset adoption is quite low.

The concepts of "same activity, same risk, same regulation" and proportionality to risk should inform the regulation of crypto-assets.

At the present time, a great deal of cryptoasset activity is either not governed at all, has murky restrictions, or does not adhere to any applicable norms or laws.

Though policymakers have achieved some headway, there are still many important questions about the domestic and international regulation of crypto-assets, such as the authority, missions, and instruments of relevant institutions.