Harvard Paper on Central Banks: Buy Bitcoin!

With help from Derek Robertson and Daniel Lippman

CAMBRIDGE, MASS.— Bitcoin was invented to bypass the world’s central banks, so the idea that these banks would start buying Bitcoin in bulk ranks somewhere from counterintuitive to far-fetched.

But after Western governments froze Russia’s foreign exchange reserves early this year, speculation grew that some central banks would acquire cryptocurrency as a form of insurance against financial blockades by the United States and its allies.

In the months since, there has been little more than speculation. But the idea has remained a fixation among Bitcoin investors, who tend not to support US foreign policy goals and see it as a good thing that crypto could provide a solution.

Bitcoiners’ hopes often revolve around the Gulf states, with their huge cash reserves and often full relations with the West. In August, a Twitter account inspired by the opportunity, Sheikh Roberto sprouted up to promote Bitcoin use and slam the Fed in posts from El Salvador.

Last week we pressure tested this idea in talks with crypto entrepreneurs on the sidelines of the Milken Institute’s Middle East Summit in Abu Dhabi. There, we found no indication that Gulf state central banks were considering Bitcoin purchases, despite their interest in blockchain technology.

But elsewhere the idea is very much alive, at least in theory. A new working paper on the subject by Matthew Ferranti—a fifth-year PhD candidate in Harvard’s economics department and adviser to former Fed chairman Ken Rogoff, now a Harvard professor—has caused a minor splash.

In it, Ferranti argues that it makes sense for many central banks to hold a small amount of Bitcoin under normal circumstances, and much more Bitcoin if they face sanctions risk, although his analysis finds gold to be a more useful sanctions hedge.

DFD caught up with Ferranti at Harvard’s Cabot Science Library to discuss the working paper, which has not been peer-reviewed since its initial online publication late last month.

What are the implications of your findings?

You can read texts, for example in the Wall Street Journal, where people say: “We overused sanctions. It’s going to come back to bite us because people don’t want to spend dollars.” But the contribution of my paper is to put a number on it and say, “Okay, how big of a deal is this really? How much should we be concerned about that?”

The numbers that come out of it are that yes, it is a concern. It’s not just you changing your Treasuries by 1 percent or something. It’s much bigger than that.

Instead of hedging sanctions risk with Bitcoin, shouldn’t governments just avoid doing bad things?

It’s not just one thing that gets you on the US sanctions list.

If the only thing that could get you sanctioned, for example, was invading another country, then most countries, as long as they don’t plan to invade their neighbors, probably don’t need to worry about this at all, and so my research becomes less relevant.

But it’s kind of a nebulous thing. It might make countries stop and think, “How trustworthy is the United States?”

The paper does not say anything about whether it is good or bad to use sanctions. There is a huge literature on how effective sanctions are. And I think the number that comes out of that is like a third of the time they work. Of course, they can have unintended consequences, such as harming the population of the country you are sanctioning.

We hear a lot about crypto and sanctions evasion, but from the perspective of central bank reserves, you’ll find that gold is a more useful hedge. Why?

Because it is so much less volatile. It is five times less volatile.

[Coincidentally or not, the level of gold accumulation by central banks smashed its previous all-time record in the third quarter of this year, though it remains a mystery which central banks were doing the buying. -Ed.]

So why should a central bank bother with Bitcoin?

They are not correlated. Both kind of bounce around, so there’s a diversification benefit to having both.

And if you can’t get enough gold to adequately hedge your sanctions risk – consider a country that has very poor infrastructure, doesn’t have the capacity to store large amounts of gold, or countries that have so many reserves that they simply can’t buy enough gold. Places like Singapore and China. You can’t just turn around and buy $100 billion worth of gold.

Based on Russia’s disastrous experience with the privatization of the 1990s, some would say that the lesson of recent history for non-Western countries is: “Beware that Harvard economists are giving advice.” Should people trust your findings?

[Laughs] This is a framework for thinking about this topic. You may agree with the assumptions built into it. Change the number and run the case again, and you will get results that are adapted to your beliefs.

If you were advising the Treasury on sanctions policy, what would you tell them?

I believe the decision to freeze a country’s reserves is so important that it must be made by the president.

What would you say to the president?

Try to make concrete the vagueness of how we apply sanctions.

Last Friday, the White House published an unpretentious memo which has major political consequences.

In the letter, Shalanda D. Young, director of the Office of Management and Budget, provides guidance to federal agencies to comply with a order from earlier this year who ordered them to “quantum secure” their cryptographic systems. The guidance includes telling agencies that they have until May of next year to report their most vulnerable systems, that agencies should designate someone to take the lead on such “cryptographic inventory projects” and that each agency will be required to produce an annual report as such until Deadline 2035 for quantum secure federal systems.

When that kind of bureaucratic attention to detail comes in, you know the government is serious. The memo also creates a task force to help coordinate the decades-long quantum security project, led by the Biden administration’s chief information security officer, Chris DeRusha, who called it in a statement “the start of a major undertaking to prepare our nation for the risks that this new technology provides.” — Derek Robertson

A tidbit from the world of lobbying: Applied Intuition, a Silicon Valley-based startup that develops software for autonomous vehicles, has launched its own political action committee.

POLITICAL influence reported in May on the company’s efforts to expand its footprint in DC, including hiring lobbyists and a former aide to Rep. Marcy Kaptur (D-Ohio) to help with her mission to “advance the deployment of safe and reliable autonomy in the civilian and defense sectors.”

By taking the next step and launching a PAC, the group said in a statement, it hopes to “accelerate the adoption of secure and intelligent machines” that Army’s Robotic Combat Vehicle and Toyota’s efforts for autonomous vehicles — its hybrid defense/commercial business model is relatively unusual in the field. — Derek Robertson and Daniel Lippman

Keep in touch with the whole team: Ben Schreckinger ([email protected]); Derek Robertson ([email protected]); Steve Heuser ([email protected]); and Benton Ives ([email protected]). follow us @DigitalFuture on Twitter.

Ben Schreckinger covers technology, finance and politics for POLITICO; he is a cryptocurrency investor.

If you have had this newsletter forwarded to you, you can sign up and read our mission statement on the links provided.