An American strategic crypto reserve will force governments to change regulatory frameworks

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By Arjun Goswami and Praveen Singh

The creation of a strategic crypto reserve by the Trump administration in the US this month is one of the most significant demonstrations of faith in the crypto ecosystem by any government. The move also lends legitimacy to an asset class that has consistently been challenged by governments around the world, including in India, for its lack of intrinsic value. It can very well be a turning point for the crypto industry as the largest economy in the world officially endorses crypto assets with the creation of these strategic reserves.

Counterintuitively, Bitcoin prices dropped by over 4 percent the same day as the announcement. The market probably accounted for the fact that the strategic reserves in the US would be created only out of the crypto assets that have been legally confiscated by the US government agencies, and there would be no additional investment by the US to acquire such assets.

What is a strategic reserve?

Strategic reserve refers to the stockpiles of any critical resource that is held back from normal use by governments or other organizations, and which can be released during times of crisis or supply chain disruptions to provide liquidity in the market. For instance, most governments today maintain a Strategic Petroleum Reserve to ensure energy security. A common theme for most of these strategic reserves is that these commodities or items are critical for the functioning of an economy, and the government can release such reserves at appropriate time to deal with any crisis and stabilize the economy.

How would a crypto reserve differ?

Unlike most other strategic reserves, crypto evidently does not have any intrinsic value, and therefore is not crucial for the normal functioning of an economy. It appears that the crypto strategic reserve in the US is not meant to deal with any crisis, but instead to maximize the profits for the government through these assets. The White House statement clearly shows this intent by highlighting that premature sales of bitcoin have already cost US taxpayers over $ 17 billion. Thus you can think of the strategic reserves as a long-term investment by the US government in crypto assets, meant for booking profits eventually when the crypto prices have peaked. This is more akin to a sovereign wealth fund in the form of a sovereign cryptocurrency fund.

Are there risks?

However, building crypto reserves in the form of a sovereign cryptocurrency fund is not without its risks. Even traditional sovereign wealth funds are often plagued with governance issues and, if commodity based, can exacerbate a natural resource curse. In addition, crypto reserves do not automatically provide an intrinsic value to the crypto assets. Crypto assets continue to remain volatile and there are no direct use cases of it for a government. It is also worth noting that crypto assets have so far not acted as a hedge against the economic slowdowns and their prices have typically shown a direct correlation with the stock market indices, i.e., their prices move together. If this correlation continues, liquidating crypto assets at the time of economic downturns may not be helpful and therefore any country following the footsteps of US must also consider the situation when a crypto reserve will really be used.

At a time when the US dollar as a reserve currency could be challenged in the future, the heavily dollar linked cryptocurrency reserve could be seen as bolstering the US dollar.

Winners and losers

According to President Trump, the strategic reserves would comprise of Bitcoin, Ethereum, XRP, Solana and Cardano. While this list may be updated later, it creates a group of winners and losers in the move. The five crypto tokens forming part of the strategic reserve could grow exponentially while the other tokens may just disappear from the market. As with any form of industrial policy that results in the Government choosing market winners and losers, this may not work in the interest of competition and innovation in an industry where innovation is a foundational bedrock. Accordingly, fair play and competition between different crypto tokens may have to be ensured through regulations.

Conclusion

While these concerns and risks will continue to be articulated, the strategic crypto reserve is an unambiguously positive move for the crypto world. The impact of US endorsing crypto assets will be felt by all other economies, just as it is felt with the movement in dollar value. It now requires other nations to seriously reconsider their existing crypto policies. Clear policies and regulations on crypto assets may soon materialize in different jurisdictions, including in the US where a task force set up by the Securities and Exchange Commission (SEC) is already working on creating a regulatory framework for crypto assets. We also expect greater institutional interest in crypto assets now that the largest economy has officially endorsed crypto through the strategic reserves. Governments around the world will need to consider getting back to the drawing board and think about building a regulatory framework that facilitates innovation in crypto without building unnecessary risks for the economy.

(Arjun Goswami is Director- Public Policy and Praveen Singh is Senior Associate, Cyril Amarchand Mangaldas.)

Views are personal and do not represent the stand of this publication.