Hedging Sanctions Risk: Bitcoin in Central Bank Reserves | Article Review \ stacker news ~econ

After a long hiatus, I'm back with another academic article review. Shout out to @scoresby for sourcing the article (#1216945). I'm always interested in reading academic articles related to Bitcoin, but don't usually have the time to go looking them up since it's not technically my field of study.

Also, I used to put these posts in ~BooksAndArticles because I wanted the exposure from @siggy47's newsletters, but I think I'll put them in ~econ from now on since it's the more natural fit. (When crossposting?)

Anyway, today we'll be taking a look at Hedging Sanctions Risk: Cryptocurrency in Central Bank Reserves, by Matthew Ferranti who works at the University of Cincinnati Cryptoeconomics Lab. The paper was published in 2025 in the Journal of International Money and Finance.

Overview

This paper seeks to address the question of whether central banks should hold cryptocurrency as a hedge against sanctions risk. It is purely a simulation based paper, meaning it builds a model of various assets and simulates outcomes under different central bank portfolio choices.

Sanctions are modeled as a purely exogenous shock that devalues the central bank's holdings of particular assets. For example, US sanctions are modeled as resulting in the total loss of US treasury holdings and a 2/3 loss in the valuation of global stock valuations. EU sanctions are modeled as resulting in the loss of Euro denominated holdings and a 1/3 loss in global stock valuation. Gold and cryptocurrency (which the paper simply calls Bitcoin) are modeled as unsanctionable.

The main result of the paper is shown in the figure below. This shows the optimal portfolio allocation to Bitcoin at various degress of risk aversion and sanctions risk. The red line shows the optimal Bitcoin allocation of a country with a very high risk of sanctions, whereas the dotted gray line shows the optimal Bitcoin allocation of a country with no risk of sanctions. The horizontal axis measures the degree of risk aversion. The result suggests that countries with low-risk aversion should in general hold some Bitcoin, regardless of their sanctions risk. Countries with high risk-aversion with low risks of sanctions should not any Bitcoin, but countries with high-risk aversion and high sanctions risk should hold around 10-20% of their portfolio in Bitcoin.

Do the authors understand Bitcoin?

One question I ask of every paper is whether or not it seems like the author(s) actually understand Bitcoin. In this case, the author clearly does. There is an entire section of the paper (Characteristics of Cryptocurrency) dedicated to discussing the nature of Bitcoin, including decentralization, proof-of-work, and why it would be difficult for countries to censor the network.

Critiques of the paper

If I had to critique the paper, it would be a general critique of all simulation based papers. To trust the results you really have to trust the model, and the model is greatly simplified. For example, Ferranti assumes that sanctions risk is independent of the central bank's choice of portfolio holdings. But in reality, the US may threaten sanctions against countries that try to de-dollarize. Another questionable assumption is the absolute uncensorability of Bitcoin. We agree that Bitcoin is censorship resistant, but there at the nation-state level there are many actions that the US or other world powers could take to make transacting with Bitcoin difficult for a small country.

Thus, I find the results fascinating and in-line with my understanding of Bitcoin's role as a censorship-resistant monetary network; but I question the real world applicability of the simulation rseults.

Interesting tidbits

Section 3 of the paper explores the relationship between sanctions risk and gold reserves. In it, Ferranti provides this interesting plot showing the relationship between gold reserves and military imports from the U.S. Countries that import less military equipment from the U.S. are shown to accumulate greater gold reserves. While not conclusive evidence that this is related to sanctions risk, it is consistent with that narrative.
Section 4 of the paper offers this interesting chart showing the share of Bitcoin mining by country. It shows that China has greatly declined in importance of Bitcoin mining whil the US has greatly increased.

Takeaways for Bitcoiners

To me, the main takeaway is that you can present your friends with "academic proof" that Bitcoin is useful as a censorship resistant asset, even though the "proof" is somewhat suspect since it's based on simulations only. (The simulation is only as good as the model and the assumptions that go into it.) Still, it's better to have some corroborating evidence than no evidence, right?

The other takeaway are the interesting charts showing the relationship between gold reserves and military imports, and the share of bitcoin mining by country. These are useful data points to have in your back pocket as you talk about Bitcoin in various capacities.

30 sats \ 0 replies \ @Solomonsatoshi 2h

Cryptocurrencies are moderately sanctionable because they are DINO.

Bitcoin is the only cryptocurrency that can be considered highly resistant to sanctions.

Even gold can be impacted by localised sanctions in some cases for example Order 6102 although it is arguable whether the US could freeze gold reserves held by any nations central bank as it would require it to block the transfer of that gold to any other entity.

41 sats \ 1 reply \ @Undisciplined 6h

Does the author provide any discussion of what to expect when various assumptions of the model are relaxed?

42 sats \ 0 replies \ @SimpleStacker OP 6h

Not really. But even if they did, I don't know if it'd be too insightful... the optimal allocation to Bitcoin would probably just go down (if they were to address my specific critiques)

0 sats \ 0 replies \ @Solomonsatoshi 1h

Most nations are still monetarily and militarily subservient tribute states to the US. There is however a growing alliance of nations increasingly openly challenging US military and monetary hegemony. Since Roman times if not before monetary and military hegemony have usually gone together...along with dominance in trade. The US gained global dominance post WW2 and after the fall of the Berlin Wall that dominance transformed into unopposed global hegemony.

But today China is now challenging US monetary and military hegemony- building up a stronger military and increasingly aligning with nationed sanctioned out of the USD SWIFT trade payments system. China is now too important in global trade for the US to sanction or exclude directly- when the US tried to impose tariffs China responded by cutting off the supply of rare earths that the US needs for its military and high tech manufacturing.

There is a widespread and tragic denial in the west of the powerful position China now occupies in global trade. It is hard for US Exceptionalists to understand let alone accept how China has come to enjoy such a dominant position because they do not understand the central importance of governments in the creation of the wealth of nations...they seem blind to the repeated, numerous and continued projections of power the US government has orchestrated during its time of global dominance.

China is very unlikely to adopt Bitcoin for trade payments- it has already built its CBDC and the CIPS and mBridge digital trade payments platforms which provide trade payments outside of the USD/SWIFT network. As the USD/SWIFT protocol declines the Chinese protocols become increasingly important.

No major nation can now afford not to trade with China- including the US. The era of US hegemony is waning.

As the US empire declines Bitcoin is likely to be a useful neutral safe haven asset but international trade is now so strongly dominated by China it is hard to see Bitcoin being used for trade payments in a major way. Bitcoin might be more useful as a reserve for central banks wanting neutrality from US and Chinese spheres and protocols and if enough neutral nations central banks come to hold Bitcoin it could possibly be used for trade payments between them.