After raising more than $63 million from digital currency donations, Ukraine has now legalised its crypto sector, allowing exchanges to operate freely and mandating banks to open accounts for crypto companies. This move further legitimises the rise of digital or virtual currencies and raises pertinent questions surrounding their role in geopolitics.
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Already, some tech companies have the power, resources and influence to rival nation states and as digital currencies become more pervasive, they could test the resolve of a world order based around geography. In an article for Foreign Affairs, Parag Khanna, the founder of FutureMap, describes why technology is beginning to redefine traditional geopolitics. He writes, “Network proximity is now on par with physical geography, and basic geopolitical assumptions about citizenship, migration, power projection, and the use of force need to be rethought for the digital world.”
However, before looking at how cryptocurrencies and geopolitics intersect, we first need to understand what cryptocurrencies are, and what a future dominated by them could look like.
What is a cryptocurrency?
According to Tim Massad, a former chairman of the US Commodity Futures Trading Commission, a cryptocurrency is defined by three key elements. First, that it is a digital representation of value, second, that it can be transferred electronically and third, it is recorded in a digital ledger that is widely accessible. There are two primary types of digital currency, one issued by the state, and the other, by a private entity.
Sovereign digital currencies, like China’s Digital Yuan, are government issued. Also known as Central Bank Digital Currencies (CBDCs), they, like fiat currencies, are validated by the central bank of the issuing country.
According to Aaryaman Vir, a crypto entrepreneur who spoke with indianexpress.com, CBDCs have “very little to do with crypto, with the crypto element in question contingent on how Central Banks issue the currency and keep track of it.” For Vir, being decentralised is a core element of ‘real’ cryptocurrencies (essentially public sector variants) and without that design principle, CBDCs are very similar to existing currencies, they just operate on newer technology.
In contrast, private-sector digital currencies generally rely on decentralised blockchain technology to settle accounts between users. Those currencies include Bitcoin and Ether, which fluctuate in value relative to the US dollar, and also a subset of cryptocurrencies called stablecoins, like Facebook’s Diem, which are pegged to a fiat currency and designed to remain relatively stable.
So, what are the advantages of adopting cryptocurrencies?
For consumers, transferring money becomes a lot cheaper and in certain instances, safer as well. Transaction costs of cryptocurrencies are much lower than fees levied by most banks. Additionally, transaction values cannot be replicated. For example, if you were to buy a concert ticket from ticketmaster.com, the issuer would send you a pdf of that ticket. I could then potentially sell that pdf to multiple people, with no one realising that they have been scammed until the second person arrives at the door of the event. With cryptocurrencies, I couldn’t do that. Once you have sent the value to one person, you can’t send it to anyone else.
For governments, CBDCs could be useful if they can exploit first-mover advantage. China for example is miles ahead of its counterparts in the development of a sovereign digital currency and is on its way to set up exchanges with other countries. Similarly, countries can take advantage of cryptocurrencies by introducing favourable regulations (like Portugal) that would incentivise capital landing.
Cryptocurrencies also have the potential to transform the entire financial system. According to Balaji Srinivasan, the founder of Coinbase, Central bankers have largely quashed price discovery making it very difficult to get a sense of the health of individual companies or the real economy as a whole from asset prices. However, with digital wallets, you could potentially hold every asset on your computer, from cryptocurrencies to CBDCs to fiat currencies, every stock, and even, a minute of your time or a gigabyte on your hard drive.
In practice, if everyone adopted digital currencies, we would create a decentralised finance matrix (defi matrix) where every asset competes against every other asset. Srinivasan argues that such a matrix would represent extreme capitalism, removing geographic advantages from global markets and ensuring complete price discovery. Khanna writes that this change is ushering in a new era of global monetary competition, “where national currencies must earn their place in someone’s wallet portfolio every hour of every day, even among citizens of their own countries.”
Ending American financial hegemony
The US Dollar is the dominant reserve currency and is the benchmark through which global trade is conducted. As a result of this dominance, according to Vir, the US can manipulate its currency at will, often resulting in ramifications for the whole world. Citing one example, Vir notes that when the US left the Iran nuclear deal, many European countries wanted to continue doing business with Tehran. In response, the US threatened to exclude any companies in violation of US sanctions from the SWIFT banking system, which was established in the 1950s and is controlled by a select few large banks.
Washington would cease to hold that influence over companies and states if the dollar was replaced by digital currencies.
Many are in favour of such a drastic shift. Elon Musk and Mark Zuckerberg have both argued that digital currencies are better suited for a more multipolar world as they are free from the control of any individual nation. However, currently, the two biggest competing powers namely, America and China, are not trying to democratise the monetary system but instead, cement their own influence over it.
China, for its part, stands to gain from the decline of the Dollar, but is banking on the Dollar being replaced by the Yuan or Digital Yuan. According to a report from Carnegie India, “In order to challenge the dollar’s hegemony and internationalise its currency, China will have to move away not just from the Dollar but also from the payment rails dominated by the Dollar. The best way to simultaneously do both would be to introduce a new payment rail like CBDC.”
China’s race for digital dominance is in line with Beijing’s ambitious foreign policy under President Xi Jinping. According to Massad, many think of his One Belt One Road (OBOR) project in terms of physical infrastructure, it’s actually more about building networks, broadband and other types of digital infrastructure to create the foundation upon which a future payment system would function internationally. The Digital Yuan is being used by over 220 million users in China and the Chinese Central Bank has already explored a digital currency cross-border payment project with Thailand, the UAE and Hong Kong.
However, according to Justin Muzinich, a fellow at the Council on Foreign Relations, “as real as this danger is, the United States should not panic.” As the use of SWIFT declines, the dollar’s role in the global market will be eroded as well. However, a Digital Yuan in and of itself would not account for foreign investors’ lack of trust in China’s markets, especially given the volatility of its government. Additionally, as the US is engaged in discussions aimed at setting standards for the underlying technology, it would presumably have a role in shaping that technology as well. In short, we are nowhere close to entering a post-dollar world, let alone a world dependent on Beijing.
Developing nations
Aside from the US and China, who are both competing for international supremacy, no other country wants the Dollar or Yuan to be the global reserve currency. According to Vir, “cryptocurrencies make sense for anyone who doesn’t want to be a global hegemon because they are by definition neutral and not controlled by any single nation”.
Around 75 per cent of the world’s population, more than 60 per cent of global GDP, and around 50 per cent of all billionaires are neither American nor Chinese. While Beijing and Washington may compete, according to Khanna, “rather than being forced to take sides in a new Cold War,” countries can instead form an “Aligned Movement” in which they rally around a decentralised currency to facilitate cross border trade. This would result in a “decentralised race to the top as countries, cities, companies and communities – physical and virtual – compete to attract talent and capital.”
While larger countries India, South Korea and the US have approached cryptocurrencies with waves of regulations, smaller countries are looking to fill the void left behind. For them, cryptocurrency would not facilitate geopolitical influence, but could induce capital inflow and transform their economies into international crypto tax havens. More importantly, for several Latin American countries, a digital currency would free them from the clutches of the US and international institutions like the International Monetary Fund (IMF).
El Salvador, for instance, recently adopted Bitcoin as legal tender. For close to a century, the US has intervened in South America to prop up authoritarian regimes (think to countless examples during the Cold War) and exploit natural resources (giving birth to the term banana republics). More recently, the CIA has allegedly participated in two coups, in 2014 in Brazil and in 2019 in Bolivia.
Washington responded to El Salvador’s move with dismay, a sentiment echoed by the IMF, an institution for its own part, that has also come under much criticism for its interventionist policies. In 2019, when Ecuador was in a severe economic slowdown, the IMF stepped in to loan it $4.2 billion. However, in exchange, Ecuador was forced to adopt huge spending cuts, which even the IMF acknowledged would increase unemployment and poverty.
Given that the total capital on defi systems today amounts to approximately $60 billion, it is conceivable to imagine a world in which countries were no longer dependent on US aid or IMF loans, but instead directly borrowed money from the rest of the world, without having to jump through hoops for the same.
Similarly, for a country like India, Srinivasan argues that adopting digital currencies is of paramount importance. He states that “a network that cannot be shut down by any state is a network that India and its diaspora can rely on in times of conflict.” Pointing to the fact that millions of Indians are dependent on American apps like WhatsApp, PayPal and Google, Srinivasan expresses concern over the disproportionate influence that Washington has over India.
In a worst-case situation, Srinivasan warns that “given sufficient negative press, American technology companies may ban the Indian Prime Minster or Indian citizens not just from entering the US, but from much of the internet itself.” While such an example may seem extreme, the logical extension of non-alignment diplomatically would be non-alignment culturally and economically as well. Crypto could be a means of achieving that.
Concerns
While embracing cryptocurrency might have its benefits, if structures are poorly designed, it could also result in the adverse destabilisation of financial systems. For one, it could weaken governments’ ability to set monetary policy. According to Muzinich, “a cryptocurrency like Bitcoin could conceivably become a common enough medium of exchange” that coin holders, rather than central bankers, could end up deciding to increase or decrease the amount of digital currency in circulation. Speaking about America in particular, Muzinich argues that the widespread adoption of cryptocurrency could not only take important monetary decisions out of the control of the US government, but also allow foreign powers to accrue influence over the US money supply by, for example, buying large quantities of stable coins.
Additionally, cryptocurrencies pose significant security risks. In an article titled Are Terrorists Using Cryptocurrencies, a collection of authors posit that the lack of regulation surrounding cryptocurrency exchanges, could benefit terrorist finance methods by allowing radicalised individuals to send money to groups like the Al Qaeda or ISIS. On a smaller scale, drug traffickers, ransomware attackers and money launderers can all make use of blockchain technology to operate outside of the legal framework.
Then there’s the question of sanction evasion. If the global financial system is overturned, countries like China could conduct trade with the likes of North Korea or Russia outside of the shackles of Western sanctions. Nations like Iran could also take advantage of cryptocurrencies, with approximately 4.5 per cent of bitcoin mining already taking place in Iran. According to blockchain analytics firm Elliptic, at its current level of mining, Iran’s bitcoin production would amount to revenues close to $1 billion a year. The US currently imposes an almost total economic embargo on Iran so bitcoin revenues play an important role in buying imports and lessening the impact of sanctions for Tehran.
As discussed previously, cryptocurrency can also have the reverse effect. Due to the ease and speed of transaction it allows, crypto has empowered relief efforts in Ukraine. The country accepts millions of dollars in donations via digital currencies and many Ukrainians have been drawn to cryptocurrency as a place to invest their money as there is no strong stock market alternative.
Like all technology, cryptocurrency exchanges are neither inherently good nor bad. Whether they are used to transform the current economic order for the better or worse will depend on how systems are designed, regulated, and adopted. However, one thing is certain. Individuals, companies and governments who move quickly will be the ones to benefit most and will perhaps have the biggest role in shaping this new digital reality.
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