For the last couple of years I’ve been thinking about whether, and how, sovereigns (i.e. governments) might adopt Bitcoin (and /or another crypto) in some fashion. Until recently this has been a decidedly fringe concern, but now that billionaires and listed companies are getting in to Bitcoin faster than you can count them, numerous other commentators have started to discuss the possibility of sovereign adoption — Garrick Hileman being one of the most prominent and recent.
It’s worth examining the various possibilities facing governments when thinking about how they will respond to Bitcoin — and respond they will surely have to. Bitcoin might constitute a tiny fraction of the global financial system today, but if its historic rate of growth continues, it will account for a significant contribution within a decade, and be a major component within 20 years. Growing numbers of investors and companies are realizing that they can’t afford to ignore Bitcoin. Likewise, if governments leave the decisions too late it could be very costly.
Many central banks are interested in issuing so-called Central Bank Digital Currencies (henceforth CBDCs). Some are even on the verge of releasing their currencies into the wild. This development has been driven in part by the success of Bitcoin, as well as the undoubted advantages a natively digital currency can offer. We’ll come back to CBDCs another time (but get started here), for now I want to concentrate on governmental interaction with crypto that runs on a public blockchain and which is open to anyone and everyone, and in particular Bitcoin, which has the most liquidity, and accounts for the majority of all crypto value.
Bitcoin is becoming unignorable for governments. How should they respond? The available options seem to fall into the following categories:
1 — Ignore Bitcoin (Tried. No longer credible.)
2 — Ban Bitcoin (Very difficult, and politically expensive. Some have tried, and failed.)
3 — Hold Bitcoin as part of their Central Bank or Sovereign Wealth Fund reserves (Very possible.)
4 — Hold Bitcoin as part of an intergovernmental treasury, perhaps through the IMF. (Possible, but probably in the future)
5 — Allow regulated commercial firms to offer custody and BTC-based instruments (Already happening.)
6 — Some combination of 3, 4, and 5
7 — Launch their own CBDCs (Already underway)
Before we examine some of these options in detail, we need to consider why assets such as real estate, gold, and especially Bitcoin, are so attractive to professional investors right now. The answer is mainly because the US and EU (and others) are printing money on an epic scale in order to ward off economic depression and to keep their economies afloat in the midst of a global pandemic. The immediate aim of governments is to keep people in jobs and keep people spending, and they mostly do this by pumping money — oceans of it — into the economy in various ways.
Where does all this money come from? Traditional economics says that it can either be borrowed from future tax receipts, by issuing government debt (bonds), or else printed by the central bank which then buys various kinds of debt (so-called quantitative easing). Once the crisis is over, the debt is supposedly sold on and the money burnt, cancelling out the money printing. Alternatively, the debt can be allowed to mature, at which time the principal is repaid, and then the central bank can burn the money it magicked up. Needless to say, no one seriously thinks any central bank will follow through on the second part of the QE process and burn or cancel the printed money…
The only other way for a government to put money into the economy is for the central bank to print money, and simply put it into the government’s account where it is used directly to fund government policy — so-called monetary financing. Historically this approach has ended very badly whenever it has been tried.
Investors are worried that with so much newly-printed money sloshing around the financial system looking for somewhere to go, and more to come, asset prices will balloon further and thus reduce the value of government-issued currency (fiat money). This is precisely what is happening — a kind of sector-specific inflation. When the value of a currency is falling, or you think it is about to fall, you want to hold as little of it as possible; you want to sell it for something else, something that won’t devalue relative to the rest of the economy — usually stocks, or real estate, or else another currency or commodity, such as the Swiss Franc or gold. Of course, no one else wants to hold the devaluing currency either, so prices in that currency go up.
Gold and Swiss Francs are known as “sound money” — defined as a monetary asset that is a reliable and easily convertible store of value which is therefore in demand at times of crisis (experts argue about whether the Swiss Franc is sound money in the technical sense, but it is certainly sounder than any other fiat currency). Bitcoin, even though it is a very poor currency (largely because it can handle so few transactions), might nevertheless be described as “super-sound money” — a kind of money that cannot be inflated away, or cancelled, or confiscated, by government action. Moreover, Bitcoin is by its nature “deflationary “ — it tends to gain value relative to other assets because of its scarcity and popularity as an inflation hedge. As a result it is an excellent store of value — one of the three essential criteria of money (the other two being a unit of account, and means of exchange). It is no surprise therefore, that Bitcoin has become ever more desirable to professional investors over the last year. This trend is likely to continue.
Bitcoin might offer some tempting advantages to governments, but it also presents a threat, and to some countries it looks like a big scary one: the loss of control over the money supply. Whoever controls a nation’s money supply controls everything in that country. Governments will not surrender this power lightly, if at all. This point cannot be emphasized enough.
Fortunately, Bitcoin’s threat to monetary stability is almost entirely illusory.
No one “controls” Bitcoin (even if the market is manipulated from time to time by so-called whales, which in turn is only possible because governments have so far refused to regulate Bitcoin in the same way as other money markets). If anyone wanted to gain control over Bitcoin (to double spend coins, or censor transactions, for example), they would have to spend an enormous sum of money in order to carry out what is known as a “51% attack”. Even then, it couldn’t possibly be done in secret; everyone would see it, and in response there would almost certainly be a hard fork, after which everything would carry on as before. The attacker would have wasted many billions.
But there is another way for a government (and it could really only be a government, or group of governments) to effectively control Bitcoin: purchase a sufficient quantity of the circulating coins to control the market. This purchase would not need to be a majority of available BTC. Far less would be needed to achieve market supremacy, and even less to achieve mere market dominance. Even at today’s record prices, the G7 could act collectively (either informally or through the IMF) and buy, say, 33% of all circulating Bitcoin (about 5 million BTC). The cost to each government would be modest in budgetary terms, and, of course, the action itself would boost the price enormously, so there would likely be no net fiscal cost at all.
Integrating Bitcoin into a national financial system, even if only at the lowest level, as a savings instrument, not only renders the money supply threat moot, but it would also trigger further positive feedback loops. The very fact of state adoption would act as a voluntary (if modest) layer of policy restraint on the national Treasury — an action to which markets typically respond positively. Moreover, making crypto trading subject to the same regulation as any other financial instrument would put an end to the scams and manipulation that are still, sadly, too common in the sector. In addition, state adoption would add security and credence to the blockchain, and reduce volatility, which would make it yet more attractive. And even if the price of one Bitcoin were to reach USD$10 million as Hal Finney famously speculated, and the Bitcoin network thus represented a value several times greater than all the world’s gold, there need be no danger to the status of the major fiat currencies, in the same way that the gold price almost never disturbs the value of fiat. What risk there is comes from the same source it always comes from: governments trying to defy economic gravity and enforce an unsustainable policy, such as trying to strongarm the exchange rate, as Britain’s government attempted in September 1992. Famously, it didn’t go well. Just as heat always rises, so value only ever flows one way: from low-confidence instruments into high-confidence ones.
Grayscale currently owns about 2.7% of all outstanding BTC. In reality they own much more — many Bitcoin are lost forever, and many more are out of circulation for other reasons.
Several other large companies own between 0.1% and 0.03% of the Bitcoin stock. In total, about 5% (in practice more like 7% or 8%) are held by listed companies (Ref). Every week more companies announce purchases.
On top of this are the private hedge funds, family offices, and other rich individuals. We can only guess at their holdings.
The rich are getting into Bitcoin. Even the Financial Times is publishing pieces that are favourable — unheard of a few months ago.
If this trend continues, at some point the pressure for sovereigns to adopt will become overwhelming. There are already a few pointers that this might be on the cards: the US Comptroller of Currency has just authorized US banks to be custodians and use public blockchains for settlement; the Ukrainian central bank is working with a public blockchain (Stellar) to build their CBDC; Some German banks are offering custody. This is not an exhaustive list. As Gavin Davies, adviser to the UK Treasury, said recently, “Digital currencies are here to stay.” (Ref paywall)
Sovereign adoption, when it comes, will have an extraordinary effect on the market — everyone will jump in, at the same time. To forestall this as best they can, governments would almost certainly want to purchase quietly over many months. How long this secret could be kept is anyone’s guess given that enormous fortunes will be made. My own view is that a government known to be open to digital currency will be first — perhaps Japan, Switzerland, or Australia, and they will use an unconventional vehicle for the program. Whatever the case, as soon as the rumours start, the price of BTC will increase rapidly as all the world’s banks and investment houses rush to get a slice of the pie.
It might happen tomorrow. How bad are you going to feel if you wake up and Bitcoin has gone up 3, 5, or 10 times overnight? Bitcoin is going to become an official reserve asset (it’s already an unofficial one)— the ultimate savings instrument, available to everyone, everywhere. This is not one to miss.
