On 1st October 2016, the Chinese Yuan became the world's 5th reserve currency. What does it take to become one and can Bitcoin get there?

What are reserve currencies?

The term reserve currencies today denotes currencies which form part of the International Monetary Fund's SDR (Special Drawing Rights) basket. SDR was created by the IMF in 1969 as a reserve asset, as there was a shortage of existing reserve assets (gold and the US Dollar) to support the expansion of world trade.

The currencies which form part of the SDR basket are the US Dollar, Euro, Japanese Yen, Pound Sterling and from 1-Oct, Chinese Yuan. The US Dollar will continue to constitute the major currency in the SDR basket, with a weight of 47%.

How did the Chinese yuan become a reserve currency?

The composition of the SDR is reviewed by the IMF every five years. The SDR's constitution (currencies and respective weights) is broadly expected to reflect the relative importance of currencies in the world's trading and financial systems.

If the IMF determines that a currency is freely usable (widely used for payments in international transactions and widely traded in the principal exchange markets), it may decide to add that currency to the SDR basket.

The benchmarks used to measure this include use of a currency in reserves of other countries, currency trading volumes, debt denominated in that currency, etc. With China's increasing importance to the global economy and the increasing number of Yuan-denominated transactions, it was decided to add Yuan to the SDR basket after the last review in November 2015.

Does Bitcoin have a chance?

While Bitcoin may become the unofficial reserve currency (favourite safe haven asset) of people worldwide, it is unlikely to become a part of the IMF's SDR. Even if Bitcoin-denominated transactions pick up across the world, major global economies fill find it difficult to support its inclusion.

The IMF is, after all, a global body controlled by its members – governments of different countries. The fixed number (21 million) of bitcoins that can be issued is also a disadvantage – the IMF will want a currency whose supply can mimic the global growth in trading volume. This is one reason why other currencies were added to the SDR basket, apart from the US dollar.