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Hedging sanctions risk: Cryptocurrency central bank reserves - Matthew Ferranti www.sciencedirect.com/science/article/pii/S0261560625001688

426 sats \ 5 comments \ @Scoresby 11 Sep econ

• The paper simulates the returns of Bitcoin and other reserve assets. • The simulations balance expected return, volatility, and sanctions risk. • In the presence of sanctions, there is no completely safe asset. • The model shows that cryptocurrency can act as a form of insurance. • Sanctions risk may propel broader diversification in central bank reserves. simulations balance expected return, volatility, and sanctions risk. • In the presence of sanctions, there is no completely safe asset.

AbstractAbstract

Central banks may shift their international reserve holdings in order to protect themselves ex-ante against the risk of financial sanctions by fiat reserve currency issuers. For example, from 2016 to 2021, countries facing a higher risk of US sanctions increased the gold share of their reserves more than countries facing a lower risk of US sanctions. This paper explores the potential for Bitcoin to serve as an alternative hedging asset. I describe a dynamic Bayesian copula model to simulate the joint returns of Bitcoin and other reserve assets under a wide range of plausible sanctions probabilities, quantifying the extent to which varying levels of sanctions risk increases optimal gold, renminbi, and Bitcoin allocations. I conclude that sanctions risk may diminish the appeal of US Treasuries, propel broader diversification in central bank reserves, and bolster the long-run fundamental value of both cryptocurrency and gold.

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102 sats \ 0 replies \ @optimism 11 Sep

In the presence of sanctions, there is no completely safe asset. [..] In the presence of sanctions, there is no completely safe asset.

What makes it that Russia is still selling crude and refined petrochemical products?

102 sats \ 0 replies \ @0xbitcoiner 11 Sep

"..., quantifying the extent to which varying levels of sanctions risk increases optimal gold, renminbi, and Bitcoin allocations."

That renminbi allocation got me thinking! I checked out the paper and, honestly, it kinda makes sense in the scenario they described.

7.1.3. With sanctions affecting bitcoin and gold7.1.3. With sanctions affecting bitcoin and gold

In this-section, I relax my previous assumption that sanctions leave the central bank’s gold and Bitcoin untouched. Rather, I now assume that the central bank must offer a discount to market price in order to entice buyers to violate sanctions to transact with the central bank. For example, Katinas and Rushwood (2024) show that Russia offered a discount relative to Brent crude to attract buyers of its oil following its invasion of Ukraine in 2022. The discount has varied over time depending on the type of oil, but has ranged as high as 30 %.

In Fig. 14, I assume that US financial sanctions require a central bank to offer a 20 % discount to sell gold and Bitcoin, effectively reducing the value of the gold and Bitcoin by 20 %. I assume EU financial sanctions result in an additional 10 % discount, and Chinese financial sanctions also result in a further 10 % discount. A central bank sanctioned by all three entities would need to offer a 40 % discount to transact in gold and Bitcoin. In this scenario, renminbi bonds are more attractive, because renminbi bonds diversify against the risk of Western sanctions relatively better than gold and Bitcoin. Thus, Western policies that strictly enforce sanctions on gold and Bitcoin transactions could enhance the international appeal of the renminbi.

0 sats \ 1 reply \ @Undisciplined 11 Sep

Cc: @SimpleStacker

0 sats \ 0 replies \ @SimpleStacker 11 Sep

Ooooooo nice

@remindme in 2 days

0 sats \ 0 replies \ @Entrep 11 Sep

Did the model account for the fact that large-scale adoption by central banks would itself fundamentally alter Bitcoin's return distribution and volatility profile? It seems like there would be a strong feedback loop.