Should Cryptocurrencies be included in the forex reserves of Central Banks?
Interesting paper by Profs. Winston Moore and Jeremy Stephen of University of the West Indies (Cave Hill). They try and figure whether it made sense for Central Bank of Barbados to hold cryptocurrencies like bitcoin in their forex reserves. What they are trying to figure is would addition of these currencies lead to any benefits like lower volatility etc?
They say the impact would not have been much:
This paper provides an assessment of the potential benefits and costs of holding Bitcoins as part of the portfolio of international reserves using the case of Barbados. Within recent years, the proportion of digital transactions done using digital currencies has grown significantly. As a result, it is possible that digital currency could become a key currency for settling transactions. In addition, given that Barbados maintains a peg against the US dollar, it is necessary that the Central Bank of Barbados holds enough of various currencies as a precaution against speculative attacks.
The paper uses two main empirical tools to conduct the analysis: a counterfactual exercise using historical performance of the various exchange rates (including Bitcoin) as well as a Monte Carlo forecasts of international reserves for the next 1, 2, 5 and 10 years using a relatively small portfolio composition of Bitcoin (0.01 percent). The counterfactual exercise suggests that had the Central Bank of Barbados held a relatively small proportion of its portfolio in Bitcoin between 2009 and 2015, the impact on reserve balance volatility (due to exchange rate variation) would not have been significantly different from that experienced due to other major currencies.
In addition, the appreciation in the value of the Bitcoin portfolio (in US dollars) would have also generated a significant return for the Bank. The Monte Carlo forecasting exercise yields similar results.
However, the paper notes that as the proportion of reserves held in Bitcoin rises, the volatility of reserves would also increase. Given that the proportion of transactions done by Barbadians in digital currency is not likely to exceed 10 percent of all transactions in the short run, it is therefore recommend that if Bitcoin is incorporated into the portfolio of foreign balances of the Central Bank of Barbados, that its share should be relatively small.
These currencies have hardly made any ground so far. It will be interesting to see how they evolve in future. . It would be quite something for central banks to invest in currencies they have not created.
Infact with these currencies gaining ground, central banks are likely to loose their monopoly printing powers. They could just resemble a govt owned bank trying to maximise returns on its portfolio. The case for having a central bank at the first place shall weaken significantly..