Putin's War Could Turn Central Banks Into Crypto Battlegrounds

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The Turkish lira had lost 44 percent of its value versus the dollar in one year before handing over the unenviable distinction of the world's worst-performing currency to the Russian ruble. Its purchasing power at home has also dwindled: depending on whether you believe official figures or private assessments, inflation in Turkey ranges from 54% to 124%. So, how did the residents react? For one thing, the tech-savvy classes opted for cryptocurrency.

According to experts at the Bank for International Settlements, the lira's proportion of all currencies swapped for stablecoins — blockchain tokens that offer 1:1 convertibility into physical assets (mainly US dollars) — increased to 26 percent by the end of last year, from 0.3 percent in January 2020. Given that the Turkish currency accounts for only 0.5 percent of the global foreign-exchange market, a 26 percent participation is quite rare.

It used to be that civilizations that lacked an acceptable medium of exchange for sellers of goods, services, and assets would "dollarize," with the US currency serving as the national unit of account in everyday transactions. Prior to the 2015 restriction on the use of foreign currency in domestic transactions in Indonesia, one-fifth of Jakarta's office skyscrapers charged rent in dollars.

But, if the dollar was an impediment to sovereign nations fully controlling their monetary destiny, "cryptoization" may be an even greater challenge: "Adoption of a crypto asset as the main national currency carries significant risks and is an inadvisable shortcut," the International Monetary Fund warned in October last year, shortly after El Salvador made Bitcoin legal tender.

El Salvador could be an exception, and Turkey could be a result of President Recep Tayyip Erdogan's unconventional economic policies. However, Russia has raised the stakes. Sanctions put on the world's 11th-largest economy for invading Ukraine may provide a significant drive to cryptoization: According to Kaiko, a blockchain analytics business, volume in ruble-denominated trade in Tether, a dollar-backed stablecoin, is rapidly increasing.

"When the banking system is damaged, whether by financial sanctions or conflict, people will rush to crypto to secure their assets and retain liquidity," says William Je, CEO of Hamilton Investment Management Ltd. Himalaya Exchange, a cryptocurrency exchange that debuted its trade token, Himalaya Coin, last year, was founded by Je. Hcoin is now worth $43 billion on the market. "Russians have been extremely engaged in the cryptocurrency business," he claims.

Widespread token use would drain deposits from financial systems. As coin transactions elude fiscal watchdogs, tax income may suffer. Less official money equals less seigniorage – the profit earned by the monetary authority on assets purchased by issuing low-cost cash and cash-like liabilities. Because a central bank can only print the national currency, it cannot address a crypto liquidity shortfall; financial stability may be compromised. Digital assets may enhance exchange-rate volatility by acting as a conduit for capital outflows.

Above all, cryptoization poses a threat to the present financial order, in which banks are tasked with denying liquidity and store-of-value services to individuals whom Washington intends to punish. Coins on decentralized ledgers can erode America's policing power by functioning outside the financial system. According to US President Joe Biden's March 9 executive order, digital assets may be used "as a means to circumvent United States and foreign financial sanctions regimes." They may even sidestep centralized exchanges by transacting in peer-to-peer, or P2P, transactions.

"There are legitimate concerns that cryptocurrency could be used for criminal operations or to circumvent sanctions," Je argues. "Peer-to-peer platforms are a frequent technique to accomplish this." However, if authorities collaborate closely and provide clear and coordinated guidance to crypto operators, the issue can be readily resolved." Know-your-customer, or KYC, standards for onboarding members of a trading venue may be one such requirement. "Whether it's peer-to-peer transfer or chat channels, you must register with complete information," Je adds.

Why aren't prices reflecting the fact that forces are aligning in favor of crypto adoption? While Bitcoin originally fell along with other risky assets, the number of non-zero-balance Bitcoin addresses has surpassed 40 million, reaching an all-time record, according to Bloomberg Intelligence analyst Jamie Douglas Coutts. "Bitcoin is positioned for appreciation once macro forces diminish," he adds, adding that the number of wallets that have only purchased and not sold Bitcoin "continues to achieve new highs, climbing 20 percent over 12 months and accelerating in recent weeks."

HODLers, or users who are "Holding On for Dear Life," are displaying more conviction than in previous bear markets. More institutional money is being poured into the market. "I've spoken to several asset managers and investment banks, and every one of them has started to invest in crypto or is investigating it," says Hamilton's Je, a former chairman of Macquarie Group's Greater China equity capital markets. "Whether you like it or not," he argues, "the cryptocurrency market will continue to exist and flourish."

According to the BIS report, once digital assets are widely accepted as a form of payment, any problems with them — such as disruptions to a stablecoin or a drop in the price of a volatile token — might bleed over to payment networks and have a negative impact on real economic activity. The risks are exacerbated, according to the researchers, by "unknown unknowns" caused by a lack of openness on currency ownership.

Arguments that Bitcoin is too volatile to be used as a daily currency, or that volumes on P2P exchanges are too small to sustain widespread token adoption, are valid in normal times. People don't need a desperate alternative when their banking system is linked to a massive pool of global liquidity and their currency is guaranteed by a monetary authority with unrestricted access to large amounts of foreign-exchange reserves. However, when neither criterion is met, the rules of the game alter. As they might have done in Russia.

The weaponization of the dollar and the SWIFT network has sent shivers around the world. The response could be widespread cryptography. The strain on monetary sovereignty that authorities feared would result from Meta Platforms Inc.'s intention to back Libra stablecoins has returned with a fury, despite the fact that the project, renamed Diem, is no longer active. The threat should be taken seriously.

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