A reserve currency is a currency used globally to facilitate trade, act as a stable store of value, and support the balance sheet of central banks. The dominant global reserve currency is the US Dollar, which accounts for a large portion of all foreign currency holdings. Reserve currencies are often accepted for international trade even by two third-party countries that do not accept the currency as legal tender.
There are hundreds of actively used currencies worldwide, but only a few are viable for use in international trade. This is for various reasons: the currencies of small nations are often highly volatile, illiquid and may be subject to state controls. Therefore, it is beneficial to use widely accepted currencies with a stable value to facilitate trade, and also to ensure central banks have access to a useable currency in the forex market. In most instances, this currency is the USD, although the EUR and CNH are also sometimes used in this manner.
Reserve currencies are safe haven, ‘risk off’ assets used to protect value. Normally they can be expected to have a stable valuation, and perhaps to increase in times of market turmoil as investors rotate out of riskier plays. Reserve currencies such as the USD are highly liquid and can be traded freely at any time of day, due to their global usage.
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