echnology and policy, or policy and technology – quo vadis?
Editor’s Note: This is the first of a two-part series examining the evolving place of cryptocurrencies and their regulation within the global trading system – and whether crypto could be used as a “back door” for Russia, potentially bypassing economic sanctions.
A race is on. In this race, technology regularly outpaces policy and law, yet sometimes politics wins by a nose. Consider that it was not so long ago that the world’s leading government-issued (or fiat) currencies –the dollar, the euro and even the renminbi—were contending for leadership in the global trading system. So-called “currency wars” were common in international monetary debates but also were an undercurrent in discussions of strategic competition. Amid these debates, a new digital invention suddenly appeared on the sidelines: Bitcoin and the blockchain. Shortly thereafter, with technologists and libertarian elements leading, Bitcoin competitors have begun proliferating. Cryptocurrency momentum is mounting, often led by tech evangelists and start up financial concerns around the globe. Investments in these cryptocurrencies, the value of which was denominated in fiat currencies, ballooned from millions to billions to suddenly trillions.
Crypto proponents claimed that cryptocurrencies were on the way to making national fiat currencies of limited significance, if not entirely obsolete. Proponents of digital finance—known by the acronym DeFi—were working toward this by reengineering the global financial infrastructure to make financial services cheaper, faster, more secure, and more personalized. Banks, central banks, and international financial institutions began to recognize that cryptocurrency was not a novelty but a transformational invention. Currency debates in geopolitical discussions began shifting from which fiat currency would prevail in the competition to whether fiat currencies would survive at all.
As these debates took place, cybercriminals – ever the resourceful bunch – found another use for cryptocurrencies, breathing new life into previously low-impact ransomware. By 2021, ransomware was the cybercrime of the day, mentioned in national security policy documents and used to great effect against critical infrastructure, hospitals, and other crucial portions of society. According to ChainAnalysis, cryptocurrency-enabled crime hit a new all-time high in 2021, with illicit addresses receiving $14 billion over the course of the year, up from $7.8 billion in 2020.
Russia’s invasion of Ukraine has again transformed currency and national strategy debates, this time more by politics rather than technology. Russia’s unprovoked invasion put enormous pressure on the international financial system, motivating the most rapid and comprehensive economic sanctions against a state in history. Countries around the world sought to pressure Russia into halting its aggression by quickly adopting policies designed to deny Russia access to conventional banking institutions. Only two days after Russia’s invasion of its neighbor, a joint statement by the United States and the leaders of the European Commission announced economic sanctions focused with uncharacteristic precision for a diplomatic document; “We will hold Russia to account and collectively ensure that this war is a strategic failure for Putin.”
Despite the speed with which sanctions were settled upon, these measures always take time to have an impact even while the situation on the ground evolves. Now, the hottest question in the currency debates is not whether fiat currency is dead, but whether cryptocurrencies may be used to circumvent economic sanctions. Can a “crypto back door” be employed that would successfully circumvent a sanctions regime? In this case of Russia, could this back door be used as a bridge to the yuan, allowing circumvention of the sanctions and, potentially, facilitating the decline of the dollar and the euro in favor of protecting the ruble or even contributing in the long term to the rise of the yuan as a global reference currency?
Dollar Dominance—Seigniorage and its Critics
The American dollar’s rise to become first a reference currency and then a relied-upon currency was the product not of design but of circumstance. A short history would describe how the need to rebuild in the aftermath of the Second World War – leading to the Bretton Woods agreements, international institutions, and other agreements relating to reconstruction efforts. All of these agreements left the U.S. in a pivotal position. After the Allied victory, the role of the dollar as the benchmark currency—or “reference” currency as it became widely known, was criticized often, most notably by the communist world and by non-aligned countries.
Amid fevered efforts to overthrow the so-called unipolar world ostensibly controlled by the United States, Bitcoin – which was the product of decades of cryptological innovation - appeared. The circulation of Satoshi Nakamoto’s Bitcoin “white paper” in 2009 started a revolution which transformed the currency debates in unexpected ways. Turnover and fiat currency investment in cryptocurrency, first Bitcoin and then others, began to grow. As adherents began to believe that they no longer would have to rely on fiat currencies, the idea gained traction that cryptocurrencies could replace many fiat currency transactions and fiat currency could lose its intrinsic value.
The notion that fiat currencies would suffer fell partly in line with those whose political agendas involved displacing the role of the dollar as a reference currency. But only in part, because these people sought not to supplant a fiat currency with a cryptocurrency but rather to replace one fiat currency with another. Their political goal was to wrest the so-called seigniorage advantage of the dollar and transfer that advantage to another currency, the euro, the ruble, the yuan, or some other fiat unit.
The seigniorage advantage of a dollar is a subtle economic concept. According to the definition that many economists use, seigniorage is the difference between the face value of money, such as a $100 bill, and the cost to produce it. The $100 bill is a fairly sophisticated coupon, and each is reported to cost 14 cents to produce. Critics of the role of the American dollar in international affairs complain that it is unfair that when monetary authorities circulate each new $100 bill, they receive $99.86 of value in all international transactions. This appears to be unearned income. But this is a wooden dollar interpretation of the concept of seigniorage. It fails to take into account that today only a small amount – about 4%—of all economic transactions take place with the physical exchange of bills. The vast bulk of exchanges now are in the form of dollar denominated transactions through bank transfers, checks, electronic payment systems, travelers’ checks, credit cards, and so on. The number of physical bills in circulation plays a marginal role in the total volume of money except in those pockets of the economy in which transactions rely on bills. Even more important, the burden of maintaining the dollar for widespread use, both in U.S. jurisdictions and outside these jurisdictions, bears the costs of unilaterally providing a common good which is available to anyone conducting transactions in dollars. The currency must be monitored and managed, for instance to protect against fraud such as counterfeiting and manipulating. Unlike coins, paper bills have a relatively short life and must be replaced on a regular basis.
The real importance of seigniorage in international transactions is what might be called the seigniorage advantage. The seigniorage advantage is passive and hard to calculate, but it might be thought of as the equivalent of an interest rate. This passive interest rate grew after the disintegration of communist international institutions and at the same time as electronic transactions began overtaking physical banking transactions. The seigniorage advantage is the “imputed interest”—imputed because it accrues but is not charged—to the transactions taking place using dollars. What is the total sum of this interest? The answer depends upon the measurements one uses. But a simple way to think of benefits of seigniorage of a fiat currency is to think of people assembled in a line. The person first in the line generally has advantages relative to the persons further behind in the line.
The invention of cryptocurrency has transformed the debate over the dominance of the dollar in terms of Bitcoin and pressure is mounting. In Part II of this series, we will reflect on the use of cryptocurrencies in Russia, safe havens, side doors, and attempts to circumvent sanctions through the use of cryptocurrencies.
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The Rise of Crypto and How it Disrupts Currency Systems
Image via Unsplash.
March 24, 2022
In the first of a two-part series, Marshall Center professors Sean S. Costigan and Gregory Gleason examine the rise of cryptocurrencies and how it unsettled the traditional currency-based trading system - all with an eye toward considering whether crypto could undermine sanctions on Russia.
T
echnology and policy, or policy and technology – quo vadis?
Editor’s Note: This is the first of a two-part series examining the evolving place of cryptocurrencies and their regulation within the global trading system – and whether crypto could be used as a “back door” for Russia, potentially bypassing economic sanctions.
A race is on. In this race, technology regularly outpaces policy and law, yet sometimes politics wins by a nose. Consider that it was not so long ago that the world’s leading government-issued (or fiat) currencies –the dollar, the euro and even the renminbi—were contending for leadership in the global trading system. So-called “currency wars” were common in international monetary debates but also were an undercurrent in discussions of strategic competition. Amid these debates, a new digital invention suddenly appeared on the sidelines: Bitcoin and the blockchain. Shortly thereafter, with technologists and libertarian elements leading, Bitcoin competitors have begun proliferating. Cryptocurrency momentum is mounting, often led by tech evangelists and start up financial concerns around the globe. Investments in these cryptocurrencies, the value of which was denominated in fiat currencies, ballooned from millions to billions to suddenly trillions.
Crypto proponents claimed that cryptocurrencies were on the way to making national fiat currencies of limited significance, if not entirely obsolete. Proponents of digital finance—known by the acronym DeFi—were working toward this by reengineering the global financial infrastructure to make financial services cheaper, faster, more secure, and more personalized. Banks, central banks, and international financial institutions began to recognize that cryptocurrency was not a novelty but a transformational invention. Currency debates in geopolitical discussions began shifting from which fiat currency would prevail in the competition to whether fiat currencies would survive at all.
As these debates took place, cybercriminals – ever the resourceful bunch – found another use for cryptocurrencies, breathing new life into previously low-impact ransomware. By 2021, ransomware was the cybercrime of the day, mentioned in national security policy documents and used to great effect against critical infrastructure, hospitals, and other crucial portions of society. According to ChainAnalysis, cryptocurrency-enabled crime hit a new all-time high in 2021, with illicit addresses receiving $14 billion over the course of the year, up from $7.8 billion in 2020.
Russia’s invasion of Ukraine has again transformed currency and national strategy debates, this time more by politics rather than technology. Russia’s unprovoked invasion put enormous pressure on the international financial system, motivating the most rapid and comprehensive economic sanctions against a state in history. Countries around the world sought to pressure Russia into halting its aggression by quickly adopting policies designed to deny Russia access to conventional banking institutions. Only two days after Russia’s invasion of its neighbor, a joint statement by the United States and the leaders of the European Commission announced economic sanctions focused with uncharacteristic precision for a diplomatic document; “We will hold Russia to account and collectively ensure that this war is a strategic failure for Putin.”
Despite the speed with which sanctions were settled upon, these measures always take time to have an impact even while the situation on the ground evolves. Now, the hottest question in the currency debates is not whether fiat currency is dead, but whether cryptocurrencies may be used to circumvent economic sanctions. Can a “crypto back door” be employed that would successfully circumvent a sanctions regime? In this case of Russia, could this back door be used as a bridge to the yuan, allowing circumvention of the sanctions and, potentially, facilitating the decline of the dollar and the euro in favor of protecting the ruble or even contributing in the long term to the rise of the yuan as a global reference currency?
Dollar Dominance—Seigniorage and its Critics
The American dollar’s rise to become first a reference currency and then a relied-upon currency was the product not of design but of circumstance. A short history would describe how the need to rebuild in the aftermath of the Second World War – leading to the Bretton Woods agreements, international institutions, and other agreements relating to reconstruction efforts. All of these agreements left the U.S. in a pivotal position. After the Allied victory, the role of the dollar as the benchmark currency—or “reference” currency as it became widely known, was criticized often, most notably by the communist world and by non-aligned countries.
Amid fevered efforts to overthrow the so-called unipolar world ostensibly controlled by the United States, Bitcoin – which was the product of decades of cryptological innovation - appeared. The circulation of Satoshi Nakamoto’s Bitcoin “white paper” in 2009 started a revolution which transformed the currency debates in unexpected ways. Turnover and fiat currency investment in cryptocurrency, first Bitcoin and then others, began to grow. As adherents began to believe that they no longer would have to rely on fiat currencies, the idea gained traction that cryptocurrencies could replace many fiat currency transactions and fiat currency could lose its intrinsic value.
The notion that fiat currencies would suffer fell partly in line with those whose political agendas involved displacing the role of the dollar as a reference currency. But only in part, because these people sought not to supplant a fiat currency with a cryptocurrency but rather to replace one fiat currency with another. Their political goal was to wrest the so-called seigniorage advantage of the dollar and transfer that advantage to another currency, the euro, the ruble, the yuan, or some other fiat unit.
The seigniorage advantage of a dollar is a subtle economic concept. According to the definition that many economists use, seigniorage is the difference between the face value of money, such as a $100 bill, and the cost to produce it. The $100 bill is a fairly sophisticated coupon, and each is reported to cost 14 cents to produce. Critics of the role of the American dollar in international affairs complain that it is unfair that when monetary authorities circulate each new $100 bill, they receive $99.86 of value in all international transactions. This appears to be unearned income. But this is a wooden dollar interpretation of the concept of seigniorage. It fails to take into account that today only a small amount – about 4%—of all economic transactions take place with the physical exchange of bills. The vast bulk of exchanges now are in the form of dollar denominated transactions through bank transfers, checks, electronic payment systems, travelers’ checks, credit cards, and so on. The number of physical bills in circulation plays a marginal role in the total volume of money except in those pockets of the economy in which transactions rely on bills. Even more important, the burden of maintaining the dollar for widespread use, both in U.S. jurisdictions and outside these jurisdictions, bears the costs of unilaterally providing a common good which is available to anyone conducting transactions in dollars. The currency must be monitored and managed, for instance to protect against fraud such as counterfeiting and manipulating. Unlike coins, paper bills have a relatively short life and must be replaced on a regular basis.
The real importance of seigniorage in international transactions is what might be called the seigniorage advantage. The seigniorage advantage is passive and hard to calculate, but it might be thought of as the equivalent of an interest rate. This passive interest rate grew after the disintegration of communist international institutions and at the same time as electronic transactions began overtaking physical banking transactions. The seigniorage advantage is the “imputed interest”—imputed because it accrues but is not charged—to the transactions taking place using dollars. What is the total sum of this interest? The answer depends upon the measurements one uses. But a simple way to think of benefits of seigniorage of a fiat currency is to think of people assembled in a line. The person first in the line generally has advantages relative to the persons further behind in the line.
The invention of cryptocurrency has transformed the debate over the dominance of the dollar in terms of Bitcoin and pressure is mounting. In Part II of this series, we will reflect on the use of cryptocurrencies in Russia, safe havens, side doors, and attempts to circumvent sanctions through the use of cryptocurrencies.
