When the price of oil crashed in 2014 (see Fig 1), Venezuela’s economy plunged into a deep recession. With the country almost entirely dependent on the substance, an economic crisis erupted, while rampant inflation rendered its currency, the bolívar, virtually worthless.
The use of cash is dwindling, replaced by easy and convenient card and mobile payments
In December 2017, Nicolás Maduro, who had become the de facto dictator of the country, took a radical step to revive the economy by announcing plans to launch a Venezuelan cryptocurrency. Called the petro, the digital coin would be backed by the country’s oil reserves.
At the time, cryptocurrencies were gaining wider recognition in the financial world as bitcoin’s price soared to record highs. The clamour around the currency reached a fever pitch in mid-December when it hit an all-time high of nearly $20,000. Just a month after Maduro’s announcement, however, the price of the world’s biggest cryptocurrency halved (see Fig 2). Since then, its value – and the value of other major digital currencies – has only continued to fall.
Nevertheless, the idea of a state-backed cryptocurrency took hold for a number of central bankers. Although the petro has been engulfed in controversy and confusion, a handful of countries are now getting serious about creating their own digital currency.
A nefarious vehicle
The petro was meant to revive Venezuela’s ailing economy and bring life back to the bolívar. Using the cryptocurrency – essentially a repackaged government-controlled asset – Maduro hoped to avoid US sanctions by making international transactions outside of the conventional banking system.
Darrell West, the founding director of the US-based Brookings Institution’s Centre for Technology Innovation, explained the appeal of cryptocurrencies for sanctioned nations: “Countries that face limitations on global trade or international transactions see these currencies as a way to operate outside the control of central banks. That gives them the power to operate autonomously with other nations even though major governments are trying to isolate them internationally.”
But the legitimacy of the petro is still hazy. Despite Maduro’s bold claim in 2018 that the petro had already raised $3.3bn, a Reuters investigation later found that Venezuela’s cryptocurrency could neither be traded on any major exchange, nor accepted as currency by any other country. What’s more, other government officials said the coin was still in development, and it is unclear whether the oil reserves said to be the basis of its value can actually be extracted.
Despite the disputes and ambiguity around the petro, other countries that are similarly shut out of the global financial system through sanctions are developing plans to create their own state-backed cryptocurrencies.
Around the time when Venezuela was gearing up to announce the petro, Russia’s plans for a digital alternative to its ruble – the CryptoRuble – emerged. In 2018, Sergei Glazyev, an economic advisor to President Vladimir Putin, told a meeting of government officials that a CryptoRuble would help Russia “settle accounts with other counterparties all over the world with no regard for sanctions”, according to a report by the Financial Times.
the disputed amount generated for Venezuela in 2018 by the petro, according to president Maduro
Iran revealed that it was also interested in developing a digital currency after the US began reimposing sanctions on the country. The coin will reportedly be called PayMon, and will be backed by Iran’s gold reserves.
Compared with Venezuela’s petro, these countries are taking a more robust approach to cryptocurrencies, according to Yaya Fanusie, a senior fellow at the Foundation for Defence of Democracies. “[Iran and Russia are] not just making an announcement and putting something out there that’s not really connected to the rest of the economy. They’re actually doing research. They’re laying the groundwork. They’re collaborating. I think their effort is a lot more sophisticated and thought out,” he told World Finance.
Even so, it is unlikely the two countries will be able to operate outside of the conventional banking system in the way they envision. Soon after Venezuela launched the petro, the US prohibited Americans from using or trading the cryptocurrency. In an article for the Brookings Institute, West and co-author Jack Karsten called the petro “deceitful” and said it offered no long-term value for international holders. They wrote: “The petro cannot stabilise the Venezuelan economy and instead exists to create foreign currency reserves from thin air.”
Circumventing financial sanctions is certainly not the only application for state-backed cryptocurrencies. Elsewhere in the world, the use of cash is dwindling, replaced by easy and convenient card and mobile payments. Sweden is expected to become the world’s first cashless society by as soon as 2023: the use of cash has been plummeting there since 2007, when around SEK 100bn ($10.7bn) was in circulation. In 2018, just SEK 45bn ($4.8bn) moved through the economy.
The ubiquity of digital payments is beginning to make cash transactions more costly for retailers
The ubiquity of digital payments is beginning to make cash transactions more costly for retailers. When cash payments fall below seven percent of a Swedish retailer’s total transactions, it becomes more expensive to manage than the marginal profit the sales offer. According to a 2018 survey by the country’s central bank, the Riksbank, only 13 percent of respondents paid for their most recent purchase in cash, compared with 39 percent in 2010.
The Riksbank is now researching a central bank digital currency (CBDC) called the e-krona. Unlike Venezuela, which attempted to create a brand new currency, the e-krona would give the public access to a “digital complement” to its physical currency, the Riksbank said, and would remain a state-guaranteed means of payment.
stolen from crypto exchanges in 2018
of illicit transactions between criminals in the EU involved bitcoin in 2015
worth of global online payments in 2017 were made in China
worth of global online payments in 2017 were made in the US
The basic benefits of digitalising a currency include efficiencies in digital payments and transparent transactions. Central banks could also allow policymakers to see every transaction in real time, allowing the bank to track every unit of currency. “So theoretically, for monetary policy [digital currencies could enable] better control and maybe more effective policy,” Fanusie said.
The Riksbank has also recognised the risks involved with implementing such new and wide-ranging technology, saying on its website: “The question of whether Sweden should introduce a state-issued digital krona is one that will affect the whole of society… By continuing to examine the scope for doing so, the Riksbank is preparing a possible way forward towards meeting a new digital payment market.”
By not acting on digital currencies, the bank said it would be abandoning the payment market to private agents, making it difficult to “promote a safe and efficient payment system”. Indeed, similar discussions are beginning to occur in other countries, such as Switzerland, which in 2018 began research into a state-backed e-franc.
While Sweden, Switzerland and others continue weighing the pros and cons of implementing a state-backed cryptocurrency, a small island nation in the South Pacific is preparing to take the plunge. The Marshall Islands plans to launch a digital currency called the Sovereign, or SOV, to its population of 53,000 by as soon as 2020.
Barak Ben-Ezer, previously the CEO and co-founder of Israeli fintech company Neema, came up with the initial idea, which quickly gained the support of Hilda Heine, President of the Marshall Islands. The government’s Declaration and Issuance of the Sovereign Currency Act in February 2018 made the idea into a legal possibility.
According to its website, as both a fiat currency and a cryptocurrency, the SOV would act as a “Panama Canal between the old world of traditional finance and the rising tide of cryptocurrencies”. It continued: “SOV is the first crypto free of the regulatory friction and ambiguity faced by bitcoin and others. It’s just money, no different than the dollar, euro or yen, and benefits from the well-established regulatory and legal framework shared by all sovereign currencies.”
Countries shut out of the financial system through sanctions are developing their own state-backed cryptocurrencies
Ben-Ezer has brought on several co-founders to help bring his vision to life, including Peter Dittus, who was the secretary general of the Bank for International Settlements (BIS) from 2005 to the end of 2016 and currently acts as the chief economist at SOV. He told World Finance that the Marshall Islands was the perfect place to test a state-backed cryptocurrency because of its small size and the fact that the country’s legal tender, since the 1980s, has been the US dollar.
“If the new cryptocurrency doesn’t work as well as you expect, you have a fall-back position. So your downside risk is very small,” he said. A country like Sweden, on the other hand, is much bigger and has a well-established currency of its own. “They must be very careful,” he warned.
Much can still go wrong when trying to incorporate a new technology like a cryptocurrency into an established economy. For instance, security systems must be carefully developed to ensure there is no way for hackers to break in, as they have at numerous exchanges in recent years. In 2018 alone, around $865m was stolen from cryptocurrency exchanges. “[Hacks] can happen to central banks as well as to private people or exchanges,” Dittus said.
On top of that, countries like the Marshall Islands that have a reputation as a tax haven must go further to ensure any new currency cannot be misused. Cryptocurrencies already have a bad name as a result of their use in illegal activities – a 2015 report by Europol said bitcoin was used in over 40 percent of illicit transactions between criminals in the European Union. Dittus stressed that the SOV would be the first fiat digital currency with anti-money-laundering and Know Your Customer provisions built into its core. The company is calling this the Yokwe protocol.
“To make a cryptocurrency a serious currency, you must make sure that it cannot be misused,” Dittus said. “You want to have this currency recognised in international transactions as well, and that means that banks and regulators across the world must accept this as a real currency.”
However, it is neither Sweden nor the Marshall Islands that presents the most exciting prospect for state-backed cryptocurrencies in Fanusie’s mind: China has long looked to push the boundaries of the definition of ‘currency’. It was in China that paper bills were first used in place of coins during the Tang dynasty, which held power in the country from 618 to 907. Today, mobile phone payments are soaring in China thanks to the widespread use of payment apps, including Tencent’s WeChat and Alibaba’s Alipay. Digital payments accounted for almost half of the global volume in 2017, according to research by PwC. That same year, $15.7trn worth of online payments were made in China, compared with just $337bn in the US.
The People’s Bank of China has been researching and actively monitoring the development of digital currencies and blockchain technology since 2014. In 2018, Zhou Xiaochuan, the former governor of the central bank, called the development of a digital currency “inevitable”.
Experts in the country are approaching cryptocurrencies in a “sophisticated and strategic way”, Fanusie said. For instance, he told World Finance, the bank’s Digital Currency Research Institute has set up think tanks in two Chinese provinces where innovators are encouraged to work on blockchain projects.
of survey respondents in Sweden in 2010 paid for their most recent purchase in cash
of survey respondents in Sweden in 2018 paid for their most recent purchase in cash
Unlike Venezuela or Sweden, China has been tight-lipped about its plans for any state-issued cryptocurrency, including what it would look like, how it would work and a timeline of when it would be launched. “They’re pretty much fertilising the environment. They’re laying down the groundwork on cryptocurrency,” Fanusie said. “China is going to be the potential game-changer.”
A Chinese digital currency would not only facilitate a cashless society, but it could also bolster monetary policy proposals, such as the Belt and Road Initiative, China’s multibillion-dollar plan for a 21st-century Silk Road.
As Jennifer Zhu Scott, a founding partner at the investment community Radian Partners, described in an article for the World Economic Forum, if the Chinese central bank used its own cryptocurrency to replace the dollar for trade along the Belt and Road Initiative, it could challenge the dollar’s dominance. “China’s digital currency revolution would expedite the accelerating retreat of the US in international trade while serving the Chinese Government’s key domestic agendas and potentially have a profound impact on… society as we know it,” she wrote.
The debate around state-backed cryptocurrencies has opened up to include key financial institutions around the world. For instance, the BIS warned central bankers in March 2018 that state-backed digital currencies could threaten the financial system by causing consumers to swarm from private banks to the central bank during times of financial instability, causing a “digital run”.
Many of the original supporters of cryptocurrencies were compelled by the idea of decentralisation
“[CBDCs raise] old questions about the role of central bank money, the scope of direct access to central bank liabilities and the structure of financial intermediation,” the BIS said in a 2018 report, adding that further research was needed on topics including the possible effects on interest rates and movements in exchange rates.
In November 2018, Christine Lagarde, Managing Director of the International Monetary Fund, argued for central banks to consider how state-issued digital currencies could boost public policy goals, such as financial inclusion, consumer protection and privacy in payments.
Speaking at a fintech conference in Singapore, Lagarde also warned of risks to financial stability and innovation, but she said the advantages of CBDCs were clear: “Your payment would be immediate, safe, cheap and potentially semi-anonymous. And central banks would retain a sure footing in payments. In addition, they would offer a more level playing field for competition, and a platform for innovation.”
She continued: “Putting it another way, the central bank focuses on its comparative advantage – back-end settlement – and financial institutions and start-ups are free to focus on what they do best – client interface and innovation. This is public-private partnership at its best.”
There are still hurdles the industry would have to overcome, however. One possible point of contention is likely to remain between those who currently promote cryptocurrencies and central bankers, who would control them: decentralisation.
Many of the original supporters of cryptocurrencies were compelled by the idea of decentralisation. Unlike a fiat currency that is controlled by a central bank, cryptocurrencies are processed through distributed ledger technology so they are not managed by any one entity. “State-backed cryptos blur the line between digital currencies and state control because they operate at the discretion of the particular government,” West explained. “The whole point of a cryptocurrency is to avoid government control.”
In the crypto world, Dittus said, decentralisation is “a little bit like a holy grail”. Although Ben-Ezer emphasised in an interview with the Next Web that the government cannot control the supply of the SOV and will have no control over how it circulates, Dittus said some centralised function is necessary, particularly in monitoring the anti-money-laundering features.
“A purely decentralised official sovereign currency cannot exist in my mind. It doesn’t work,” Dittus said. “A country’s currency that is accepted internationally must have good enough oversight by this country so that other countries will trust that this is a good currency.”
The Riksbank drew a line between CBDCs and cryptocurrencies like bitcoin to eliminate this paradox. Crypto assets like cryptocurrencies are not money, it says on its website, because “these assets lack an official issuer and do not function like a normal means of payment… An e-krona, if it becomes a reality, would be issued by Sveriges Riksbank and have the same value as banknotes and coins. [Crypto assets], on the other hand, should not be seen as currencies, but rather as a form of financial asset.”
However it is defined, experts are still split on whether they think any kind of digital currency issued by a central bank would take off.
Building national cryptocurrencies and the financial systems needed to support them will not be easy
West was pessimistic about the future of cryptocurrencies like Venezuela’s petro, telling World Finance that central banks were unlikely to trust financial tools outside conventional regulation. “Having digital currencies creates risks that monetary devices will create major loopholes in current rules on global trade,” he said.
If these institutions decide to embrace a new technology, the question remains whether digital currencies will be introduced in a year, a decade or longer. Having worked on digital money projects since 1995, Dittus said the basic idea for cryptocurrencies is the same today as it was then. “The difference is that now the technology is there, and people understand how to implement this in a relatively user-friendly way compared to 1995,” he said. He added that it is something that is “taken seriously – not just by some sort of ‘crypto freaks’, but by lots of central banks”. Dittus believes cryptocurrency technology is still in its early days, but he sees a lot of potential: “I have little doubt that some sort of digital money will see the light in many countries.”
Still, there is much work to be done establishing the financial technology infrastructure needed to support a state-backed cryptocurrency. “The system is not really built, and it’s more than just having the software,” Fanusie said. “You need to have exchanges. You have to have places where people can purchase the cryptocurrency and ways for merchants to take it. That’s not something that’s going to happen overnight.”
Building national cryptocurrencies and the financial systems needed to support them will not be easy, but technology will likely continue evolving to catch up with the idealistic plans of entrepreneurs and financial institutions, as it has in the more than two decades since Dittus first came across digital currencies. While we may be many years away from any radical departure from the paper notes and coins we carry around in our pockets, it is clear that the seed of an idea has begun to germinate.