Fence-sitting
Right from the beginning of the Russian invasion, Ukraine’s deputy prime minister Mykhailo Fedorov has walked both sides of the new global divide over digital currency that the war has exposed.
On 26 February he launched his much higher profile campaign for donations of Bitcoin, Tether and Ethereum to channel money to the resistance cause faster than a conventional appeal for international donor cash might have done. That has strikingly reportedly pulled in about US$100 million. But two days later the politician charged with digitising his country called for an expansion of the then still modest economic sanctions to the new world of cryptocurrency by demanding that on all major crypto exchanges to block the addresses of Russian users.
The Ukraine war has been a tipping point in fleshing out good and bad DeFi.
“It’s crucial to freeze not only the addresses linked to Russian and Belarusian politicians, but also to sabotage ordinary users,” Fedorov insisted in tweet which did not quite get the love his donation appeal drew. “If the goal is to put pressure on citizens to revolt against their government, revoking access to their capital will weaken their ability to do so,” was typical of the responses from the libertarian crypto crowd.
The debate about regulating “freedom money” is certainly not over as this representative Twitter user demonstrates:
The natsec and neocon types won’t like the fact that sanctions are blunt and nearing obsoletion as a tool, but if the choice is between monetary sovereignty at state and individual level and ‘everyone uses a money database controlled by a single government’, I know where I stand.
But just a month on from Fedorov exposing a new divide over the purpose of decentralised finance (DeFi) in a changing geopolitical world, it seems one of the biggest developments in global money markets for decades is being steadily drawn into the new world security order.
The new greenback
As this year began, we noted here that cryptocurrencies were facing a difficult time after last year’s soaring prices from both international financial agencies trying to catch up and investors under pressure from rising interest rates.
However, the Ukraine war has seen the more institutional end of the DeFi revolution – if not the libertarians on Twitter – broadly align with the spirit of the crackdown on Russia, at the very least in acknowledgement of the long arm of the US-led sanctions.
This was probably inevitable as crypto exchanges such as Binance developed “know your customer” procedures as they sought to become a part of mainstream finance as listed, regulated companies rather than anarchic disrupters operating the nether corners of the internet.
Nevertheless, as signs have emerged of Russians still using crypto to try to get money out of the country, the United States has been quick to warn about the consequences for the more establishment end of the DeFi system. For example one official from the new Department of Justice (DoJ) “KleptoCapture Taskforce has declared:
Financial institutions, banks, money transmission services, cryptocurrency exchanges who wilfully fail to maintain adequate anti-money laundering policies and procedures and allow these oligarchs to move money . . . will be in the crosshairs of this investigation.
While the Group of Seven threw its weight behind the new DoJ thinking as the sanctions have been broadened, the relatively positive reaction in the DeFi world to US President Joe Biden’s 9 March executive order on a digital US currency seemed to reflect a post-invasion zeitgeist shift.
Government issued digital fiat currency can been seen as an attempt to strangle the libertarian threat of DeFi, which is arguably the case with China’s well advanced digital yuan. Or it can be seen as trying to layout some road rules which mighty favour certain sorts of crypto innovation such as stable coins.
While Biden’s order called for more work on the national security aspects of crypto, establishment DeFi seems to think it can prosper better under this order than might have been the case in a new era where G7 governments are exerting control over supply chains, strategic commodities, other countries’ foreign reserves and even rogue tycoons’ yachts under the growing remit of national security.
So, in contrast to the US Federal Reserve Board’s more anodyne discussion paper on digital currency in January, Biden’s relatively rapid response can be seen as the US reasserting its financial superpower status on the back of the well-coordinated Ukraine sanctions campaign.
Going digital down under
Comments this week by the key thought leader in the Australian parliament on digital assets, Senator Andrew Bragg, tend to lend weight to the idea that the Ukraine war has been a tipping point in fleshing out good and bad DeFi.
Bragg reportedly told the Blockchain Week Australia conference, “we don’t live in a libertarian nirvana” but that Australia had an opportunity to become a crypto hub from tentative regulatory directions the Morrison government outlined on Monday.
And he said the government was concerned about crypto being used as a Russian sanctions “loophole” and he had asked the financial reporting agency AUSTRAC to report on digital currency exchanges to ensure they don’t provide a “backdoor” to support Russian interests.
While, like Biden’s order, these domestic regulatory proposals were in the pipeline before the Ukraine war, they seem to have given new momentum to ensuring that DeFi is not allowed to undermine the Russian economic sanctions. Indeed, Singapore moved quickly after Biden’s order to impose new rules on digital assets quite at odds with the libertarian vision, while at the same time promising to remain open to the new financial technology. Nevertheless, the ability of the newly reinvigorated Western alliance to stare down the challenge posed by DeFi to the Bretton Woods geo-economic order will still depend on how these new proposed domestic regimes keep up with fintech digital innovation.
Despite Bragg’s confidence everything is under control, this Australian Financial Review commentary argues that domestic regulators are still struggling to control an alternative financial system that threatens the International Monetary Fund, Western governments and the US dollar’s status as the world’s reserve currency.
Bitcoin’s bond bombs
In January as we pondered here whether disenchanted investors or newly assertive global regulators posed the most significant new challenge to crypto, El Salvador was snubbing its nose at the IMF with a planned US$1 billion government Bitcoin government bond.
The success or failure of this first attempt at a new form of fund raising via cryptocurrency could have been a big deal given the way developing countries such as El Salvador are often frustrated by the strictures imposed by the Bretton Woods agencies. With El Salvador postponing the bond issue on Wednesday, it is a bit hard to tell whether it has taken the IMF’s threats to heart or is just stung by the fall and volatility of Bitcoin since its record value last November.
Nevertheless, an interim report also on Wednesday from four central banks on using digital currencies to make cross-border transactions cheaper has only underlined how the current system of payments hurts developing countries which depend on foreign worker remittances.
The report, supported by the Reserve Bank of Australia, details how cooperation between government digital currencies should make cross-border payments faster, cheaper and safer through reduced reliance on intermediaries, and simplification of settlement processes. This is probably more about fending off the allure of crypto alternatives for some guest workers from developing countries than making the global labour market fairer. But it could contribute to offsetting the way rising security concerns about supply chains is expected to curb growth in world trade and so undermine overall global growth.
The old greenback
It says a lot about the nervousness over where the intersection of economic sanctions and DeFi leave the global financial system that Credit Suisse strategist Zoltan Pozsar has drawn so much media attention for his prediction that we are witnessing the birth of Bretton Woods 3. He argues the Ukraine war will force the monetary system designed in Bretton Woods in the United States in 1944 to shift from “inside money” created by governments and central banks to “outside money” built round commodities and gold.
“If you believe that the West can craft sanctions that maximise pain for Russia while minimising financial stability risks and price stability risks in the West, you could also believe in unicorns … After this war is over, ‘money’ will never be the same again,” the former United States financial official argues.
While the West has just reasserted its institutional power, countries which have been more equivocal about sanctioning Russia including India, Indonesia and Vietnam are still set to be a growing part of the world economy.
He says that after the freezing of Russian foreign exchange reserves more countries, like China, will diversify their reserve holdings out of Western currencies and into assets such as commodities which are beyond government control. And this will, significantly, be about diversifying financial risk as much as security risk. And Bitcoin will probably benefit.
This is a new version of the old debate about the waning primacy of the US dollar as the world’s reserve currency, which seems counterintuitive when we have just seen the most significant display American institutional economic power for a long time. For example, almost half of international SWIFT payments are settled in dollars even though the United States only accounts for about 10 per cent of world trade.
But while the West has just reasserted its institutional power, countries which have been more equivocal about sanctioning Russia including India, Indonesia and Vietnam are still set to be a growing part of the world economy. They are likely to be interested in at least exploring some alternative reserves and trade settlement currencies.
It’s a mixed picture for Australia. More commodities in reserve assets would benefit the mining industry. But more regional trade settlement in the Chinese yuan might be a bit more uncomfortable.