Government-Run Digital Currencies Could Disrupt U.S. Dominance
(Bloomberg View) -- Venezuelan President Nicolas Maduro's announcement that the Latin American country will issue a cryptocurrency called the petro to overcome a "financial blockade" by the U.S. probably mirrors the thinking of other maverick regimes. The possibility of sanctions-busting, and generally finding a way to work outside the Western-dominated global financial system, makes cryptocurrencies attractive to non-Western nations, and the more so to rogue regimes.
The West must decide soon whether it should try to regulate cryptocurrencies out of existence or join the fray -- and perhaps lose its current financial dominance in the process.
In August, the U.S. sanctioned Venezuela and its main revenue engine, the oil company PDVSA, making it difficult for them to refinance their debts -- something the nearly bankrupt Venezuelan state desperately needs to do. But if Venezuela creates a cryptocurrency for which its central bank will hold a centralized ledger, it will be able to issue debt in this currency while providing a layer of anonymity for investors. They will be able to lend money to Venezuela and get repaid in cryptocurrency, which Maduro wants them to spend on oil and other Venezuelan commodities.
The Maduro government's glaring economic incompetence makes it difficult to buy into such an ambitious project: It has already all but killed off the country's fiat currency, the bolivar, with 949 percent inflation predicted for this year by the Bloomberg consensus forecast. Why would the Venezuelan socialists be any more careful with their possible crypto offering? Saying it'll be backed by commodity reserves doesn't mean restraint will be applied. Similar ideas, however, have occurred to far more reliable economic managers, such as the Russian monetary authorities, which plan to issue a crypto-ruble in the near future -- just as the U.S. government mulls Venezuela-style sanctions against Russian debt, as well as against a potentially long list of regime-friendly "oligarchs."
Zura Kakushadze of the Free University of Tbilisi and Jim Kyung-Soo Liew of Johns Hopkins University described the potential benefits of this plan -- which could also apply to Venezuela, Iran, North Korea or any other sanction nation -- in a paper published last month. They pointed out that the crypto-ruble's promise of anonymity (except to the ledger-keeper, the Russian Central Bank) would draw international money-launderers and secretive wealthy people despite the Russian government's plan to tax any crypto-rubles whose provenance can't be explained at 13 percent, Russia's flat income tax rate: It would be a small price to pay for secrecy from Western regulators.
For Russia, creating a cryptocurrency would be insurance against the constant threat of being cut off from SWIFT, the Belgium-based quick money transfer network, the way North Korea is today and Iran was until its 2015 nuclear deal with the U.S., Russia and European nations. At the very least, a central-bank-run ledger would allow almost instant transactions inside Russia without the use of SWIFT. Last week, state-owned (and sanctioned) Sberbank conducted its first blockchain transaction with private Alfa-Bank -- a test for a future crypto-based payments system.
Using the existing, decentralized currencies such as bitcoin for sanction-busting, as North Korea appears to be doing, is way too risky because of these investment instruments' volatility and the lack of any centralized control that's built into the system. But an element of the current crypto economy would come in handy to any sovereigns starting their own digital currencies. Exchanging the Venezuelan petro or the Russian crypto-ruble would still require some kind of interface with the existing global financial system. That could be available through existing cryptocurrency exchanges. They have plenty of experience trading digital scrip that's not recognized as legal tender by any nation for U.S. dollars or euros.
Even for countries that are not in danger of being sanctioned, creating their own cryptocurrencies would be a way to shake off Western dominance and stop playing by rules set in Washington, Frankfurt or London -- at least when these rules seem burdensome. China, which has fought for years to have the yuan recognized as a reserve currency and which still punches well below its weight in global financial institutions such as the International Monetary Fund, is working on its own blockchain experiment.
Kakushadze and Kyung-Soo Liew wrote that, because of their promise of enhanced secrecy, sovereign digital currencies would undermine the global monetary system. They argued:
The world order as we know it is changing, right before our eyes. This disruptive technology – cryptocurrencies – will indeed end up disrupting the status quo. However, at least in the mid-term, forward-thinking sovereign states that embrace and adapt it to their advantage will end up being the disruptors as opposed to disrupted. The U.S. is the sovereign state with most to lose in this process, with a clear policy implication: adapt to the changing reality, issue CryptoDollar now, or risk being marginalized.
Such a bold move, however, would mean ceding many of the tools that come with global monetary system leadership. The U.S. exercises a degree of control over global corporations and governments because they use the dollar and the U.S. banking system for transactions. But moving over to cryptocurrency would make the current banking system largely obsolete for transactions, and the dollar would be just one of the cryptocurrencies out there -- big but not nearly unavoidable as today. The U.S. wouldn't be able to crack down on cryptocurrencies run by sovereign nations as it did on PayPal, which, for some years, provided a buffer layer to sanctioned entities.
The U.S. is likely headed toward a different kind of solution -- an attempt to regulate the circulation of cryptocurrencies. This year's law sanctioning Russia, North Korea and Iran calls for "a discussion of and data regarding trends in illicit finance, including evolving forms of value transfer such as so-called cryptocurrencies." Once sovereign cryptocurrencies start popping up, there will likely be attempts to regulate their conversion into dollars -- although any restrictions will be difficult to enforce if offshore entities take on the role of conversion centers.
To keep its dominant role in the global financial system, the West is essentially interested in holding back progress. That, perhaps more than anything else, gives non-Western powers, including rogue ones, a potential technological advantage born of strong incentive.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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