Reserve Currency Fallacy

There is a theory that Bitcoin will eventually be held by nations as a reserve currency and that individuals will transact using national currencies "backed" by Bitcoin. The theory asserts that transaction volume is insufficient for its use as a consumer currency, but the ability to resist debasement makes Bitcoin an ideal reserve asset. Central banks and their authorized functionaries would issue a dependent currency while holding Bitcoin on reserve. Given that Bitcoin cannot be inflated, the litany of problems produces by state control of money would be resolved, ushering in a new era of prosperity. Transaction fees would be low while transaction volume would be limitless.

Let us consider the scenario as it unfolds. Bitcoin becomes a fairly widely utilized hard currency but struggles with low transaction volume, high fees and long confirmation times. After some unspecified events unfold, national banks end up holding large amounts of bitcoin (BTC) and issue Bitcoin Certificates (BC) to facilitate trade. An auditing process is set up whereby people can verify that the ratio of issued BC never exceeds BTC reserves. Legal tender laws are passed requiring people to accept BC as payment for all debts. People purchase BC with BTC so that they can pay taxes and buy stuff from white market retailers. Eventually most Bitcoin is held in reserve.

This scenario should sound familiar, as it is how nations ended up with gold and people ended up with paper. The theory is invalid on multiple levels.

The ratio of issued BC to BTC in reserve cannot ever be effectively audited. Even if the integrity of BTC somehow remains intact there is no way to know how much BC has been issued, and there is no recourse if debasement is suspected. The member banks have to be trusted to account for their issues, and ultimately this means everyone trusts the central bank to not engage in easing. History demonstrates that this is unlikely.

For Bitcoin to be a hard money, there must be an actual decentralized Bitcoin economy. Without individuals validating BTC received in exchange, there is nobody to refuse invalid BTC as it comes to be redefined by the state. It is an error to conflate a settlement layer with substitution. Layering preserves the key security aspect of decentralization, which works against debasement, while "backing" is full abandonment of this protection.

It is very possible for Bitcoin to be held by national treasuries, but not for it to be predominantly a reserve currency. People must trade with it for it to be secure.