Why Governments Might Join the Cryptocurrency Craze: QuickTake

(Bloomberg) -- With crypto mania sweeping the world, a handful of countries have stirred at the possibility of issuing their own virtual currencies based on blockchain, the technology behind Bitcoin. For now, the idea seems most popular among autocrats looking to evade or undercut international sanctions that are enforced, in part, through the global banking system. But advocates of government-backed cryptocurrencies (so-named because they rely on cryptography for security) say that if the movement takes hold -- which is by no means assured -- it could irrevocably change the international monetary system as we know it.

1. Who is pushing the idea?

Venezuela’s president, Nicolas Maduro, is pitching a proposed virtual currency he calls the Petro, each unit of which would be backed by one barrel of oil. According to Maduro, the country received $5 billion in purchase offers in the first week of presale in February. He says it will have a “great impact” on how Venezuela accesses foreign currencies and obtains goods and services from around the world -- a reference to the nation’s dollar shortage as a result of sanctions imposed by the U.S. Success is by no means assured. There is no mechanism to exchange the cryptocurrency for crude or other hard assets, as Maduro’s plan envisions. Venezuela’s opposition-controlled parliament has declared the proposed Petro an illegal currency. And President Donald Trump signed an order blocking U.S. transactions in digital currency, digital coins or digital tokens issued by Venezuela.

2. Which other countries are considering cryptocurrencies?

Russia’s central bank plans to talk to countries including Brazil, China, India and the five former Soviet republics about creating a supra-cryptocurrency that could cover countries with 40 percent of the world’s population. People’s Bank of China Deputy Governor Fan Yifei wrote an article broaching the possibility of a digital currency it would issue with Chinese commercial institutions. In Sweden, where use of cash is vanishing, the central bank is investigating issuing its own digital currency, the E-krona, out of concern that widespread use of other virtual currencies controlled by private actors could harm competitiveness.

3. Aren’t cryptocurrencies by definition non-governmental?

Until now, yes. Bitcoin and its many competitors and imitators have developed independently from central authority -- and intentionally so. But the blockchain technology that undergirds all cryptocurrencies doesn’t preclude centralization. In theory, a government could have greater control of a virtual currency than a paper one because it would be able to keep tabs on all transactions recorded on the blockchain ledger.

4. How would governments benefit from issuing cryptocurrency?

Regulating the money supply through changes in interest rates -- i.e. monetary policy -- would be much more direct, which could mean it’s more effective and cost-efficient. Governments could crack down on tax evasion, since transactions will be traceable. Plus, for the same reason Bitcoin is so popular among people looking to circumvent government control of currency, starting a digital currency might seem attractive to any government that doesn’t like how it’s being treated by the global financial system. That includes governments facing international sanctions.

5. How could cryptocurrencies be used to avoid sanctions?

The U.S. attempts to enforce sanctions by blocking banks and companies that do business with the target country from the American financial system. Violators are traced via their transactions in the international banking system. But if a government had its own digital currency, its transactions might not be detectable to U.S. authorities. Bitcoin can provide an avenue around sanctions as well, but a government would struggle to get hold of enough of them to be meaningful. Plus, as we’ve seen, Bitcoin’s value is volatile.

6. What would this mean for the international monetary system?

The Western-dominated global financial system relies on a slew of internationally agreed-upon rules, norms and institutions that let countries trade and invest in each other. The U.S. exercises a degree of control over the system because the dollar and the U.S. banking system dominate. Should enough countries set up their own digital currencies, they would operate outside the existing framework, undermining the influence of traditional global central banks like the Federal Reserve and the European Central Bank.

7. What would this mean for banks?

In the case of national cryptocurrencies, the blockchain technology would supplant the clearing process now handled by commercial banks, undermining an important revenue stream. Banks would likely retain their role issuing mortgages and other forms of credit.

The Reference Shelf

• A QuickTake explainer on Bitcoin and blockchain.
• Regulators crack down on cryptocurrencies.
• Venezuela is jumping into the crypto craze.
• Some countries were already thinking about going cashless.
• Bitcoin might be a bubble, but blockchain is a real breakthrough, says a Bloomberg View editorial.
• What the world’s central banks are saying about cryptocurrencies.

--With assistance from Grant Clark

To contact the reporter on this story: David Tweed in Hong Kong at dtweed@bloomberg.net.

To contact the editors responsible for this story: Daniel Ten Kate at dtenkate@bloomberg.net, Laurence Arnold, Dave Liedtka

©2018 Bloomberg L.P.