Bitcoin is in vogue again:
In a Truth Social post last month, Republican presidential candidate Donald Trump expressed strong support for bitcoin … warning that any policy that seeks to hamper bitcoin “only helps China and Russia.”
Currently trading at roughly $60,000 apiece, this cryptocurrency could be had for 15-20 cents in 2010. Needless to say, some investors have made a lot of money on this entirely artificial asset.
With express interest in crypto from the presidential frontrunner, a lot of things could change on the bitcoin market—and not necessarily for the better.
Originally, people were drawn to bitcoin because it was perceived as a new kind of currency—an alternative to traditional currencies. However, bitcoin was constructed to be a digital equivalent of physical assets; the expansion of the global supply of bitcoin has come at a gradually rising marginal cost, mimicking the rising cost of mining precious metals. This trend continues until total global supply hits the perennial artificially set cap of 21 million Bitcoins.
Since the pandemic of 2020, investor interest in bitcoin has been substantially bigger than it was in the ten preceding years of the crypto asset’s existence. The market price increased approximately sixfold as a result of the global uncertainty caused by the pandemic and the erratic response to it from many governments.
Although bitcoin has both lost and gained significant value since then, the crypto has to some extent functioned as a precious, physical metal. This has attracted political interest, which normally means taxation, legislation, and regulation—all having a dampening effect on market activity. However, there is an intriguing twist to this political interest that could upset the bitcoin market in more ways than one. CNBC has the story:
Former President Donald Trump stopped short of promising to establish an official U.S. bitcoin strategic reserve currency during his Saturday keynote speech at the biggest bitcoin conference of the year. Instead, the Republican presidential nominee pledged simply to maintain the current level of bitcoin holdings that the U.S. [government] has amassed from seizing assets from financial criminals.
Coindesk.com had a slightly different take on the same story:
Former U.S. President Donald Trump promised to maintain a “strategic national bitcoin reserve” and “never sell” the government’s seized bitcoin in a freewheeling speech that tightened the Republican candidate’s grip on the crypto voting and fundraising bloc.
They also quoted Trump as saying that bitcoin someday “probably will overtake gold” as an asset.
The comparison to gold is logical in a conversation about whether or not the U.S. government should build a bitcoin reserve. However, unlike the gold reserve, which has a centuries-long logic to it, a crypto-asset reserve is difficult to rationalize, both from an economic and a fiscal viewpoint.
At the heart of the problem lies the tension between finite supply and the immense purchasing power of the United States government. Writing for Forbes, Dalmas Ngetich goes straight to the core of the problem:
With Bitcoin as a strategic asset, nothing will prevent the government from printing more cash to buy the scarce commodity. In this case, the political class and the government would be enriching themselves and their allies at the expense of the masses.
Another Forbes writer, Sean Stein Smith, adds to this point:
Since the appeal of bitcoin has been to serve as a shield against inflation, having the U.S. government printing dollars to acquire more bitcoin would seem to defeat that purpose.
The concerns that the federal government would set another inflation wave in motion are exaggerated from a quantitative viewpoint, but they are still valid. The money printing involved in building a crypto asset reserve would be insignificant from an inflationary viewpoint, but it would have a major impact on the market for bitcoin and other crypto assets.
If we take all Republican proposals for crypto-based government reserves seriously—given that they are the party closest to running the federal government after the election—we end up with a strategic reserve of 1 million bitcoin and another 1 million in bitcoin for debt relief purposes. The former is Trump’s proposal, the latter originates with Senator Cynthia Lummis (R-WY). She envisions bitcoin as a means to ease the federal government’s debt burden; according to beincrypto.com, Senator Lummis
has introduced the Boosting Innovation, Technology, and Competitiveness through Optimized Investment Nationwide (BITCOIN) Act. This bill seeks to establish a Bitcoin reserve, reflecting strategies typically used for commodities like oil and gold.
Coindesk.com adds details, explaining that the plan is to reduce the U.S. government’s debt. After spending $60-70 billion on buying up the required amount of bitcoin, the government would hold on to them “for at least 20 years” and then presumably sell them.
The only way that the federal government could do this meaningfully is if the value of the bitcoin held for debt-relief purposes grew so fast over the next 20 years that it caught up with the value of the government’s debt. I don’t know if Senator Lummis has even crunched the numbers on her plan, but let us assume that the federal government started balancing its budget next year, i.e., did not borrow a cent more than the $35 trillion (and change) that it owes today.
For the Lummis plan to work, the 1 million bitcoin anti-debt reserve would have to grow in value by an average of 36.5%—every year, for 20 years.
Is that possible? Figure 1 reports the daily close value of bitcoin over the past five years:
Figure 1
A strict year-by-year average for this five-year period shows that the Lummis plan would work well. From August 5, 2019, to August 5, 2024, bitcoin has increased by an average of almost 64% per year, well over the 36.5% annual growth needed for her 20-year plan to work.
However, Figure 1 also illustrates the significant volatility of the bitcoin price: from its top in 2022 to its 2023 low point, the bitcoin lost about 75% of its value. Or, to be more technical, the price-change amplitude for the period is 85% of the total value gain. This is very high, showing how inherently unstable the bitcoin market is.
It is theoretically possible that the bitcoin price could evolve in such a way that the Lummis plan could work. In practice, though, two things stand in its way, the first being the point made by Forbes writers Ngetich and Smith: when the government starts using bitcoin for strategic reserve and debt-reduction purposes, the asset takes on an entirely new role. It is possible, even likely, that many investors would no longer find the crypto suitable for their investment purposes.
One problem, namely, is that with a strategic reserve which, according to Trump, would never be sold, and one reserve for the Lummis debt-elimination purpose, the U.S. government would for a period of 20 years withdraw 10% of all bitcoins from circulation. This is a significant reduction in market supply—and in market liquidity.
Investors love liquidity. A 10% market shrinkage can be enough to reduce the value of bitcoin to the point where it makes Senator Lummmis’s 36.5% annual value increase an impossibility.
The other problem with the U.S. government using bitcoin for strategic and fiscal purposes is that once the 20-year mark is reached, all the 1 million bitcoins being held for debt reduction purposes will be sold off. Even if the sell-off is gradual, it will have a visibly depressing effect on the value of bitcoin.
All in all, it is difficult to find any meritorious aspects to Trump’s proposal for a perennial bitcoin strategic reserve. As for the Lummis plan, it is nothing more than an attempt to allow Congress to kick its debt can down the road. If Congress can convince itself that 1 million bitcoins today will make the debt go away 20 years from now, they have bought themselves the alibi to not have to deal with the debt until then.
We made her 20-year plan work by assuming that there would be no increase in the debt for the duration of the 20 years. This is as likely as a three-legged man running backward winning the 100 meters in the Olympic Games. A slightly more realistic outlook, allowing a $1 trillion budget deficit—in itself a modest number—to grow on par with the debt, suddenly raises the required bitcoin annual price gain from 36.5% to 41.1%.
President Trump and Senator Lummis would do America a much bigger favor if they spent their time trying to piece together a working plan for how to actually reduce the U.S. government debt. From a fiscal policy viewpoint, meddling in the bitcoin market is probably the least productive use of their time.
