A reserve currency, also known as an anchor currency, is a foreign currency that is held in significant quantities by central banks and other major financial institutions as part of their foreign exchange reserves. The reserve currency is commonly used in international transactions, trade and foreign exchange interventions. It also serves as a basis for pegging the exchange rates of other currencies. Some countries use a different currency for these purposes than their own.

What is a Reserve Currency?

A reserve currency, as the name suggests, is a currency maintained by central banks and governments as part of their foreign exchange reserves. These reserves are used by countries to pay their international debts, influence their domestic exchange rates and intervene in foreign exchange markets during periods of volatility. A reserve currency thus has significant importance in the global financial system.

The US dollar has been the world’s dominant reserve currency since the end of World War II when the Bretton Woods system was established. Other major reserve currencies in the world today include the euro, the Japanese yen, the Swiss franc, the Canadian dollar and the British pound sterling. However, the share of US dollar reserves has declined in recent decades from over 70% in the 1990s to around 60% today.

Key Qualities of a Reserve Currency

For a currency to qualify as a reserve currency, it must exhibit certain key qualities:

  • Economic power – The economy of the issuing country must be sufficiently large and stable to inspire confidence in the currency. Countries that hold those reserves need to be assured that the currency will retain its value.
  • Open capital markets – The country must have deep, liquid and open capital markets so that the currency can be easily bought and sold without significantly impacting its value. This allows other nations to acquire and hold the currency when needed.
  • Free-floating currency – A reserve currency cannot be pegged to other currencies or commodities. It needs to freely float on the foreign exchange market so that its value is determined by supply and demand.
  • Stable value – Low and stable inflation in the issuing country contributes to a stable value for the currency over time. Countries seeking to hold a reserve currency look for stable purchasing power.
  • International transactions – The currency must be used extensively in international trade and financial transactions. A currency with global acceptance and demand tends to become a reserve currency.
  • Safety – The issuing country must be politically stable with a strong central bank committed to monetary stability. This inspires confidence in its future value.

Very few currencies satisfy all of these conditions, which is why reserve currency status tends to be concentrated among just a handful of dominant economies and currencies, such as the current US dollar hegemony.

Functions and Benefits of a Reserve Currency

Reserve currencies provide certain benefits and privileges both to the issuing countries as well as to the holders of the currency. The key functions and advantages are:

Transactional and pricing medium

A reserve currency serves as an international pricing unit and medium of exchange for global trade and financial transactions. Companies engage in imports, exports and foreign direct investments can price, invoice and settle transactions in the dominant reserve currency. This avoids exchange rate risk that would be present when using a local currency.

Foreign exchange intervention

Central banks and governments can buy and sell reserve currencies on the foreign exchange market to either raise or lower the exchange rate of their domestic currency. For example, if a currency is appreciating too fast, the central bank can sell the reserve currency to boost supply and temper the appreciation.

Emergency liquidity

Holding sizeable reserves of a reserve currency allows a country to obtain immediate liquidity during periods of crisis or uncertainty. A government has quick access to the dominant foreign currency to meet international obligations.

More borrowing power

By demonstrating substantial holdings of a reserve currency, countries can increase confidence and gain access to more favorable credit terms when borrowing on international debt markets. Reserves bolster repayment capacity.

Network externalities

The more a currency is used globally, the more utility and liquidity it provides through network effects. This reinforces the incentives for central banks and firms to continue using it as the dominant reserve currency. It offers convenience and reduces transaction costs.

Seigniorage benefits

For the issuing country of a reserve currency, seigniorage refers to the ability to purchase goods and services globally by simply printing more money. Foreign holders of the currency effectively subsidize or finance spending by the issuing government and citizens.

Historic World Reserve Currencies

Although the US dollar is by far the most dominant reserve currency today, many others have served this key international role historically:

Pound Sterling – The British pound became the world’s first global reserve currency in the 18th and 19th centuries due to the expansion of the British Empire. At its peak in the late 1800s, around 60% of global reserves were held in sterling. This began declining after World War I as the British economy stalled.

Dutch Guilder – The guilder emerged as a reserve currency in the 17th and 18th centuries when the Dutch Republic was a major global trading power. Amsterdam became the world’s leading financial center during this time. However, the Napoleonic Wars eroded these advantages.

French Franc – France has twice seen its currency used globally. The first was around the era of Napoleon in the early 1800s. The second time was in the 1950s after World War II when the franc served as an anchor currency in the Bretton Woods system along with the US dollar and British pound.

Deutsche Mark – After World War II, Germany’s Deutsche mark became the second most held reserve after the US dollar during the Bretton Woods era. It remained strong until Germany adopted the euro in 1999.

U.S. Dollar – Already dominant after World War I, the US dollar entrenched its reserve currency position in the post-war Bretton Woods system in 1944, given the economic might of the United States. Although its share has declined, it remains the top global reserve currency.

Challenges to the Dollar’s Reserve Status

Despite many advantages, studies suggest some challenges have emerged in recent decades that raise questions over the current dollar-dominated monetary system and whether it can persist long into the future.

Declining economic dominance

The US economy comprised around 40% of the global economy based on GDP after World War II when the dollar became the undisputed reserve. However, that share has fallen to around 15% to 20% over the last two decades. Other nations are playing larger roles.

Loss of faith in institutions

Recurrent debt ceiling fights, political brinksmanship and partisan gridlock have undermined confidence in the competence of US political institutions in recent years. This casts doubt on the ability to maintain sound economic policy.

Weaponization concerns

The dominant role of the US dollar in sanctions, such as freezing dollar assets of targeted countries and individuals, has motivated some nations to seek alternatives as they perceive it as a foreign policy weapon.

The rise of the Euro and Renminbi

The introduction of the euro in 1999 created a viable alternative reserve currency to the dollar. Although progress has been slow, the euro now comprises around 20% of global reserves. Meanwhile. China’s push to internationalize and digitize its currency could provide an alternative over the long run.

Dollar instability

Concerns have grown among foreign reserve holders that runaway US debts and money printing could eventually undermine the stability of the dollar’s value through higher inflation or even a collapse in confidence in its intrinsic value.

Prospects for a New Reserve Currency

The current global reserve currency system continues to be dominated by the US dollar with no imminent challenger on the horizon. However, economists have proposed several alternatives if the geopolitical winds were to shift substantially:

A multilateral basket

The IMF’s Special Drawing Right (SDR) serves as a proto-basket reserve currency today, comprising the US dollar, euro, renminbi, yen and pound. Expanding the composition and use of SDRs is one approach to providing a global, basket-based alternative to the dollar.

A bitcoin standard

Given its inherently borderless and decentralized design, some proponents argue that Bitcoin could eventually serve as a apolitical global reserve asset. However, the extreme volatility of its value diminishes its current viability. Stablecoins pegged to national currencies have also been proposed.

Return of gold

Some economists favor a return to a gold standard, arguing that gold has proved its durability as a trusted, scarce asset over centuries. However, the constraints a gold standard places on modern monetary policy make this unlikely. Gold could however play a larger role in reserves again.

A stronger euro or renminbi

If policy shifts in Europe or China were to strengthen confidence in their currencies, a much larger share of reserves could migrate away from dollars and toward euros or renminbi over the next couple decades. However, US economic and military superiority will be hard to eclipse.

A lower-tech solution

Rather than a sophisticated new reserve asset, simple diversification into more local currencies, commodities and other assets could provide enough of a buffer without centralizing power in a new reserve. But this provides less liquidity and convenience.

The path forward for the global reserve system is layered with uncertainty. The US dollar retains substantial inertia and network effects that will be difficult to overcome. Any transition risks instability if not managed very cautiously and gradually. This suggests the dollar may remain the primary reserve for some time longer, but its share of global reserves is likely to continue declining as alternatives gain ground.


Reserve currencies hold a unique and pivotal role in global finance and trade. They provide liquidity, stability and a pricing medium for the international monetary system. The US dollar has served as the dominant reserve currency for over 75 years, but erosion of its economic supremacy has raised questions over its long-term sustainability in this role. Challenges from the euro, renminbi and cryptocurrencies will likely pressure the dollar’s once-impregnable position over the coming decades. However, any transition to a new reserve system brings immense uncertainty and complexities. This makes a sudden shift away from dollar hegemony unlikely in the near future. But the era of absolute dollar dominance is certainly winding down.