“There is a competition for currency supremacy. The dollar is the preferred currency in the world… The dollar is the means by which we have the opportunity to influence the economic order in the world. How will this [Libra cryptocurrency] impact the dollar?” — Rep. Al Green of Texas
Rep. Green’s remarks, which he made at last week’s Congressional hearing on Facebook’s Libra project, echo something many cryptocurrency businesses do not acknowledge: The development of digital currency technology has major U.S. national security implications. In fact, the geopolitical story around blockchain technology is likely to be more important than the purely technological and financial features most cryptocurrency enthusiasts emphasize.
The highest levels of the U.S. government certainly view crypto as a national concern. Although President Trump recently tweeted rather dismissively about cryptocurrencies, just days later, the U.S. Treasury Secretary gave a press briefing at the White House expressing his concerns about bad actors misusing digital assets. Secretaries of the Treasury do not make press statements lightly.
However, even the U.S. government’s take on cryptocurrencies is missing something. It lacks a clear framework for how the threat from bad state actors using digital currencies relates to U.S. geopolitical influence.
So, there is bad news and good news. The bad news is that there is a concerted effort by some of the U.S.’s nation-state adversaries to build cryptocurrencies and other blockchain-based value-transfer systems to upend Washington’s sanctions power. I recently co-authored a study looking at such attempts by Russia, Iran, Venezuela, and China. It found that the building blocks of a new digital financial infrastructure are being built to help “crypto rogue” states transact outside of the U.S-led financial system.
The good news is that building new payment channels does not by itself equal the displacement of the dollar. Consider why the dollar remains supreme, even when ascending economic adversaries would prefer otherwise.
China has long aimed to push the global economy off dollar dependence. After the 2008 financial crisis, Beijing pushed for nations to set up an international reserve currency system managed by the IMF, based on a basket of major currencies. This plan gained little traction.
China’s aim to displace the dollar is stymied by an unintentional equilibrium it has stumbled into with the United States. China, the world’s biggest creditor nation, is also the largest holder of U.S. treasury bonds, so China stands to take the biggest hit if the value of the dollar drops greatly. Thus, the People’s Bank of China is unlikely to make rash moves even as it seeks to undercut U.S. economic influence.
For all the rhetoric in the crypto space about cryptocurrencies one day subverting the global financial order, such sentiments do not consider the real world of geopolitics or the lessons of economic history. The dollar-led economic system in place since the end of World War II came about after years of negotiation between the two most powerful government players at the time: the newly ascendant U.S. and the weakened, war-weary British empire. The war caused seismic shifts in global political influence that economists debating monetary theories could not have envisioned decades earlier. Those shifts gave the U.S. tremendous leverage which enabled it to design the new order, with eventual, though reluctant, British support.
Reports of the demise of the nation-state have been greatly exaggerated. Nation states determine how the global economic system runs, no matter what technology exists. If one presumes that corporations and big tech have now eclipsed the power of governments, they should ask if Facebook’s Libra project will get off the ground if U.S. regulators stand in its way. The answer clearly is no.
And if one thinks that Bitcoin, because of its permissionless and open-source nature, will overcome the barriers of antagonistic nation-states, then simply observe where Bitcoin transaction volume flourishes. Bitcoin trading is most popular in two types of environments: Countries with weak financial systems and thus, where state authorities can not enforce regulatory controls (Venezuela, Zimbabwe); or, countries with strong financial systems that “allow” Bitcoin trading as a legal activity (U.S., Japan, South Korea). To see how well a strong nation-state can stifle cryptocurrency growth, just look at India or China. The Bitcoin protocol may always exist, but it will not flourish where an economically powerful nation does not permit it to do so.
But this does not mean that the dollar or the current U.S.-led financial system will be perpetually supreme. Here, again, history may be a guide and a warning.
In 1944, British economist John Meynard Keynes and lesser-known U.S. Treasury official Harry Dexter White were the lead designers of the international monetary system unveiled at the Bretton Woods, New Hampshire conference. But in the 1930s, they were theorizing, authoring articles and books, and drafting memos for their respective governments. This was a period of flux, with major geopolitical and financial volatility after World War I and during the Great Depression. Long-standing economic principles were questioned, with Keynes and White laying the groundwork for the idea that the gold standard which set foreign exchange rates in the previous century was no longer tenable. Before Bretton Woods, they were doing the intellectual work of evaluating new economic concepts and models even while the world was not ready to implement them. By the time World War II came to a close, the geopolitical leaderboard had reshuffled, with the UK heavily in debt to the U.S., enabling Washington to push through a dollar-based financial order.
The lesson: Shifts in the global financial system come about when circumstances allow governments to capitalize off the weaknesses of their rivals. And international economic systems do not develop overnight, but are constructed by those who do the homework years prior to figure out what types of systems for trade and commerce would serve them best should an opportunity arise to institute them.
The modeling and theorizing for a new global financial infrastructure is currently happening by U.S. adversaries. It is evident in the experimentation of crypto rogue states. It is no accident that sanctioned nations are prioritizing digital currency projects as part of their financial future. Russia, with banks sanctioned by the U.S. and EU, is investing in multiple pilot projects to facilitate institutional credit transactions through its banks. Since many of Iran’s banks are cut out of the SWIFT messaging system, the Central Bank of Iran is pushing its tech sector to develop a cryptocurrency-based method of transferring value. Venezuela was the first nation to launch a national cryptocurrency and although it failed upon launch, it serves as a lesson learned for others. Recently, Cuba announced it planned to start developing a state digital token.
China’s current approach to digital currency is the most sophisticated. The People’s Bank of China (PBoC) started a Digital Currency Research Initiative in 2017 and has recruited cryptographers with blockchain experience (LINK). In October 2018, PBoC researchers published an article about how China should respond if the U.S. government were to deploy a dollar-based stablecoin, a cryptocurrency pegged to a fiat currency One response option included finding ways to block such a token and deploying a renminbi-based digital currency, which the authors said was currently undergoing trial. Beijing is certainly thinking a few steps ahead about how to engage cryptocurrency-based economic threats.
The PBoC is doing now what Keynes and White did in the 1930s, researching alternative futures based on new models for currency. The U.S. dollar is not at risk of being usurped simply by the presence of these blockchain-based trials and prototypes. However, these new technologies give U.S. state adversaries creative opportunities for divergent payment channels. No one can predict the seismic shifts that may give China or other nations leverage to push through a new monetary order. But the U.S. should make sure to cultivate the economic thinkers and foreign policy strategists who understand digital currency technology and can think through paradigm-shifting scenarios so the U.S. can stay nimble and influential in the finance of the future.
Here are some signs that U.S. policymakers should watch for; indicators that a geopolitical shift is changing the global monetary order through cryptocurrency technology:
A U.S. adversary could convince other nations to use a state-based digital currency to conduct trade in the adversary’s major commodity export, such as oil. Another scenario would be an independent cryptocurrency such as Bitcoin gaining wide adoption in commerce and becoming more relevant to the global financial system. Then, a U.S. adversary could build significant reserves in the cryptocurrency and use its holdings to gain more influence in the global financial system. Another possible development could involve a U.S. adversary making progress in building digital currency wallet infrastructure. The nation could develop a state-based digital wallet system where citizens and foreigners hold and trade the digital currency and use it for transactions with domestic companies. Another situation could arise where a U.S. adversary has enough success with blockchain technology in its domestic banking system that it exports its platform to other nations to integrate into their financial sectors. Less democratic governments – who have fewer regulatory and legislative hurdles – may be the most likely to accept new financial platforms.