"[I}t will be the policy of my administration […] to keep 100% of all the Bitcoin the U.S. government currently holds or acquires into the future. […T]his will serve in effect as the core of the strategic national Bitcoin stockpile.” Former President Donald Trump, Bitcoin 2024 Conference, July 27, 2024
“Establishing a strategic Bitcoin reserve would firmly secure the dollar’s position as the world’s reserve currency into the 21st century and ensure we remain the world leader in financial innovation,” Senator Cynthia Lummis, Bitcoin 2024 Conference, July 27, 2024
A recent Wall Street Journal editorial highlighted the stiff competition for the “dumbest economic policy” proposed during the current U.S. Presidential campaign. High on the list are tariffs, food price controls, and opposition to the acquisition of U.S. Steel by a Japanese firm. We suggest adding to this list the recent proposals to establish a national stockpile, or even a strategic reserve, of Bitcoin (see citations above). Rather than accumulating Bitcoin, we urge policymakers to quickly sell whatever they have or receive.
We doubt that Bitcoin has positive long-run fundamental value. Given the energy costs of settling transactions and producing Bitcoin, as well as cryptocurrency’s role in facilitating illicit finance, Bitcoin’s social value could be very small or even negative. With this in mind, we argued that, rather than elaborating a regulatory framework that helps legitimize crypto, authorities should simply let it burn (see here and here). Indeed, in the absence of legal protections, Budish concludes that the value of Bitcoin probably would collapse if it were widely used.
However, now that the SEC has granted U.S. asset managers the authority to offer spot Bitcoin exchange-traded products (ETPs) and the Europeans have a articulated a full set of rules (MiCA), it is no longer feasible for authorities to simply ignore crypto. Rather, regulators must act to ensure that these ETPs (and any future Bitcoin vehicles) meet the same safety and soundness standards that apply to all conventional investment instruments.
But the fact that we now need to regulate crypto is surely not a justification for the federal government to hoard Bitcoin. After all, there are no stockpiles of corporate stocks or bonds. A government Bitcoin stockpile would serve only to subsidize existing Bitcoin holders. And, since Bitcoin pays no interest or dividend, this comes at the expense of domestic taxpayers. Instead, whenever it obtains Bitcoin, the federal government should aim to sell what they receive as soon as is practically possible.
In our view, the greatest long-run contribution that the federal government can make to the legitimacy of Bitcoin is to redouble the fight against the use of crypto for money laundering, terrorist finance, human trafficking and the like. Fortunately, the range of tools for detecting and tracking illicit transactions -- both on and off the blockchain – is widening (see, for example, Chainalysis’ July 2024 report on Money Laundering and Cryptocurrency). Even so, given the powerful incentives for criminals – and for foreign governments facing sanctions – to conceal payments for illegal goods and services, this critical battle will be costly with no foreseeable end.
Turning to some of the details, we start by explaining why Bitcoin may have little or no fundamental value. Unlike a stock or bond, there is no prospect of Bitcoin ever paying a dividend or interest, because there are no earnings. In addition, Bitcoin’s extreme volatility – about six times that of stocks and nearly 12 times that of high-grade corporate bonds (see Table 1) – renders it useless as a unit of account in which we could quote the prices of goods and services: just think of the enormous daily and weekly swings over the past decade in the Bitcoin price of cars or homes.
Table 1. Asset Returns and Volatility (four-week periods), 2015-September 6, 2024
Notes: The annualized return is based on the full period from the start to the end of the sample. The volatility is the standard deviation of four-week returns. The Sharpe ratio is the quotient of the average to the standard deviation of four-week returns. Stocks are the S&P 500, while bonds are AAA corporates. Sources: FRED, Yahoo Finance, and authors’ calculations.
Finally, and most importantly, there continues to be remarkably little trading of Bitcoin (see chart below). For comparison, over the past year, U.S. equity and repo trading volume averaged roughly $4.6 trillion and $79 trillion per month, respectively (see chart below). By comparison, Bitcoin’s average monthly turnover on exchanges is running closer to $22 billion. No less important, despite the remarkable increase in the price of Bitcoin, the value of monthly Bitcoin trading is running 45% below the average of the previous five years, while equity and repo volumes are up by 18% and 48%.
Trading Volume: Bitcoin, U.S. equities and U.S. dollar repo (Trillions of U.S. dollars, monthly), June 2018-July 2024
Notes: Equity volume includes NYSE and Nasdaq. Repo volume includes both centrally cleared and tri-party repo. While the Bitcoin line (red) appears to be zero, the monthly value of Bitcoin trading on exchanges in this period averaged $34 billion, compared to $4.1 trillion for U.S. stocks (blue) and $58.2 trillion for U.S. dollar repo (black). Sources: Bitcoinity.org, Federal Reserve Bank of New York, Office of Financial Research, and World Federation of Exchanges.
The continued lack of Bitcoin trading – an important indicator of liquidity – ought not be surprising. The distributed ledger technology that supports the Bitcoin blockchain limits the number of transactions per second to fewer than 10. This physical obstacle makes Bitcoin highly unsuited as a means for settling financial transactions, which occur at extraordinary frequency and scale. For example, current Visa technology permits about 65,000 transactions per second. And the repo market, arguably the most liquid of all U.S. dollar short-term fixed markets today, involves nearly $5 trillion of transactions each day! The scalability and low cost of these systems rely on extreme centralization – through enormous central clearing parties or a clearing bank – the exact opposite of Bitcoin’s distributed ledger.
Put simply, Bitcoin’s physical limits constrain its ability to operate at anything like the speed and scale of current payments and clearing systems. When Bitcoin was introduced nearly 15 years ago, it was precisely the decentralization and non-proprietary character of its blockchain that many early enthusiasts found so attractive. The current picture could hardly be more different. For example, some of today’s Bitcoin supporters advocate a centralized, proprietary layer built atop the Bitcoin blockchain in order to lower costs and boost liquidity (see, for example, Lightning network). Of course, until that innovation is proven to work through years of experience, transferring Bitcoin from one person to another will remain costly or risky (or both). (As Budish notes in his excellent Harris Lecture, there also is the irony that if there is a problem with the decentralized ledger, those harmed will turn to local authorities for legal relief.)
So, without a well of underlying liquidity to facilitate transactions, what fundamental value does Bitcoin offer? Providers of Bitcoin ETPs argue that the value lies in the opportunity for diversification. As Table 1 highlights, Bitcoin’s four-week returns show little correlation with that U.S. stocks, high-quality bonds or gold. And, despite Bitcoin’s enormous volatility, its extraordinary returns over the past decade make its Sharpe ratio – the ratio of its excess return to its volatility – higher than those of the other assets. If past proves to be prologue, these patterns mean that a well-diversified portfolio that includes Bitcoin could generate a higher return for given risk (or the same return with lower risk).
Yet, what matters going forward is expected return and volatility. Given the brief history of Bitcoin and of the extraordinary innovations associated with its evolution, why should we expect that the first decade of extraordinary returns represents a sustainable norm? Perhaps investors will anticipate the arrival of some new technology that creates a more practical crypto substitute. The more investors conclude that Bitcoin will remain an illiquid, volatile instrument without dividends, the lower expected returns are likely to become. For retail investors, most of whom gained Bitcoin exposure just in the past few months through newly-launched ETPs, and who do not plan on holding Bitcoin forever, the ETP sponsors’ ability to effect smooth redemptions in periods of heightened volatility could have a profound impact on their expectations. Indeed, experience teaches us that retail investors in mutual funds that hold illiquid instruments are run-prone when volatility surges (see our earlier post).
To illustrate these points further, imagine that we introduce a new asset that is issued based on the first documented siting of a new sunspot: call them “S-Coins.” While the number of sunspots varies cyclically, looking at annual averages since 1700, the maximum in any year was less than 200 (in 1957). Just as mathematical algorithms do for Bitcoin, these physical norms would limit the number of S-Coins issued. The central issuer could further limit the supply of S-Coins by following a rule that requires an increasing number of sunspot sightings to issue a coin. Eventually, like Bitcoins, virtually no new S-coins would be issued once the required number of sunspots rises sufficiently.
But, is scarcity alone sufficient to give S-coins fundamental value? The answer is obviously no. Unless S-Coins are generally accepted as a means of exchange, they would (like Bitcoin) have no intrinsic value, despite their scarcity. That makes S-Coins (and Bitcoins) fundamentally different from gold, silver and many other commodities used as money at various times in human history. And, to drive home the point, governments that have their own fiat currencies (which are a source of public revenue) would have little or no incentive to promote S-Coins in place of their own moneys.
All this brings us back to the point of this post: highlighting the absurdity of a strategic stockpile – let alone a strategic reserve – for Bitcoin. Strategic holdings of an asset ought to reflect urgent national needs in times of trouble. While there is great room for skepticism about the scale of the U.S. strategic petroleum reserve and the timing of its use, it is easy to imagine circumstances when this pool of fuel could serve an existential need—say, for national defense. U.S. holdings of gold are more difficult to defend. But again, history suggests that gold can be a useful means of exchange during times when there are threats to global security or severe disruptions in economic relations. Indeed, the willingness of most central banks today to hold a (small) portion of their reserves in the form of gold suggests that policymakers share this historical assessment (see here).
There is simply no strategic case for Bitcoin. The assertion that government holdings of Bitcoin will strengthen the dollar is particularly silly. Today, the U.S. government must borrow to purchase anything. In other words, a Bitcoin reserve would be a leveraged investment financed by the issuance of government bonds. The leverage problem is also a key reason why – in contrast to recent proposals – it makes no sense for the United States to establish a sovereign wealth fund. We are not Norway (see table of net international investment positions). Instead, since the U.S. government generally receives Bitcoin through criminal seizure, the prudent path is to commit to a transparent policy of selling it virtually upon receipt. Authorities around the world might also band together and agree to act similarly as a way to limit the inevitable distortions that would arise from public asset mismanagement.
Conversely, if Bitcoin’s advocates have their way, who will be the next group of politically influential and self-interested investors to propose government hoarding of their favorite asset? The issuers of U.S. dollar stablecoins or some other (temporarily high-flying) crypto innovation (think the family project of some political leader)? Large firms that issue equities and bonds? Unions that want their most supportive employers to have access to cheap funding? Big-bank executives who want to further enshrine “too big to fail”? As Kupiec and Pollack emphasize in their thoughtful critique of the Bitcoin reserve proposal, efforts by privileged parties to manipulate markets in their favor had a long history in the United States. For example, 19th-century silver-mine owners persuaded Congress to support the price of silver by hoarding the metal.
We can only hope that the silliest ideas from this year’s election season will be forgotten after November 5. But it might help if many – disinterested – economists and financial market leaders make clear now that the U.S. government should refrain from playing leveraged games with Bitcoin. Sell it all as soon as possible!