There’s a wonderful feature of cover art in a recent Coindesk article from a work of political philosophy by Thomas Hobbes, where the body of a king is composed of a mass of teeming bodies that gaze upwards at the face of their ruler. In his left hand is a sword and in his right a scepter, representing the dual purpose of governance and coercion that sovereigns find themselves wielding once they take the seat of power. It’s a visual representation of a government being the physical manifestation of the collective will of the people. Even when power is concentrated in the hands of a single individual, a government can only exist at the behest of the people who reside there. When a sovereign falls too far out of sync with the public will, the guillotines come out, the gallows form, and heads roll. The book is called Leviathan.
The news has been rife lately with stories about American lawmakers struggling with cryptocurrency regulations and decisions about whether the fed should issue an American central bank backed digital currency. These events coincide with a report released by the American Department of Justice detailing the kinds of issues law enforcement faces when pursuing criminals and nation-state backed attackers actively using the blockchain to launder money.
For XRP followers, the most important question tucked in the myriad of legislative issues has been regulatory clarity. The lack of papal blessing by regulatory bodies in the United States for the fourth-largest cryptocurrency by market cap has been a matter of friction for Ripple and members of the XRP community who feel that regulators are unfairly dragging their heels on the issue of whether XRP is a security. The lack of such a declaration hinders adoption and, as proponents of the XRP ledger argue, creates an unlevel playing field.
Paradoxically, two of the digital-assets that regulators have cleared, Bitcoin and Ethereum, are the most represented in the kinds of criminal activity and cross-border money laundering issues complained about in the recently released Attorney General’s Cryptocurrency Enforcement Framework. It’s not simply drug-traffickers and criminals who are using these digital-assets to launder money. BTC and ETH, as the Attorney General’s report outlines, are increasingly being used to bypass American sanctions by countries like North Korea, often using Chinese intermediaries to transfer these cryptocurrencies into fiat.
To drive the point home, the only two cryptocurrencies that have been granted regulatory blessing in the United States are the very same digital assets that are currently being used as tools to bypass American power on the world stage. At the same time, Ripple, an American company that created an independent and open-sourced digital-asset, is being denied regulatory clarity by some of the very lawmakers described in the Attorney General’s report as wrestling with blockchain-based criminal activity and the sanction busting behavior of rogue nation-states.
If we return to the leviathan metaphor, it seems like the sword and scepter of the American state (coercive and legislative) are dramatically out of sync. The leviathan flounders. It is unsure what to make of this new technology, unsure of how to police it, unable to fully track it, and unable to completely kill it.
Brad Garlinghouse illustrated the paradoxical and often contradictory rules and attitudes held by lawmakers in a recent tweet:
In an open letter discussing FinCEN's proposed amendment to the Bank Secrecy Act, the popular YouTube crypto commentator To The Lifeboats had this to say about the conflicting nature of attitudes on cryptocurrency enforcement:
That’s the problem here in a nutshell. FinCEN is now calling it legal tender. How does the SEC classify Cryptocurrency? In today’s environment, the agency that’s correct, is the one taking enforcement against you. That’s how US regulators have strangled the financial sector at a critical time in history.”
Lawmakers aren’t the only ones who disagree about how to treat the blockchain. In a recent panel held by the International Monetary Fund titled, Cross-Border Payments—A New Beginning, the panelists held different views on what the technology was, what it could be, and what it should be. Some felt that digital assets and decentralized ledgers would be the financial infrastructure akin to the internet, facilitating cross-border currency transfers through their underlying protocols. Others felt that this kind of transformative movement of value could only come at the behest of central banks using a layer of infrastructure that enabled seamless swaps between CBDCs without a corporate intermediary.
Some in the Cryptocurrency space view the technology as a liberator that severs financial shackles placed on the public by predatory nation-states and governments who view citizens as sheep to be periodically shorn of their wool when their respective regimes need to generate capital. Cryptocurrencies are also viewed as wealth preservers against the unmitigated printing of money. Then there are those who view the blockchain as the means to deliver fair and transparent elections, where citizens can verify that their vote has been correctly counted, and which allows them to vote from the convenience of any electronic device they may own.
The matter is made even more complicated by private sector backed digital currencies like Facebook’s Libra, which regulators were briefly concerned could supplant national currency. Corporate minted money harkens back to an age where coal miners were paid in company scrip that could only be used in company stores. And concerns abound that a private entity with no responsibility to anyone other than their shareholders could surreptitiously change the rules, locking the public into a series of predatory currency constraints. If we flip the issue on its head, a government-controlled digital asset could be used to track financial transactions with a granularity that has never been seen before. They could also block and roll back payments and freeze the funds of citizens who fall out of favor with an authoritarian regime.
For some of the above reasons, Jerome Powell, chair of the Federal Reserve argued that it was more important to get things right than to be first:
“Use of and trust in the dollar comes from the reliable rule of law, strong and transparent institutions, deep financial markets, and open capital accounts. A healthy and efficient payment system demands these features which reach far beyond the merely technological. We do think it’s more important to get it right than to be the first. Getting it right means we not only look at the potential benefits of a CBDC but also the potential risks and the important trade-offs that have to be thought through carefully. We have a responsibility both to the US and to the world that any steps taken for a US digital currency be taken safely. We’re absolutely committed to the soundness of the dollar and to a safe and efficient US dollar payment system. In addition to assessing the benefits, there are also some quite difficult policy and operational questions that need to be thoroughly evaluated. Just to mention a few, I would mention the need to protect a CBDC from cyber-attacks, counterfeiting, and fraud. The question of how a CBDC would affect monetary policy and financial stability, and how could a CBDC affect illicit activity while also preserving user privacy and security – assuming that those things can be resolved, yes there are potential benefits, but that’s going to take a lot of work and thought. They’re not simple questions, and the answers are going to need to be comprehensively understood.”
Treating open, permissionless ledgers like XRP in the same manner as Facebook’s Libra is not quite fair. I would hope that regulators were capable of cutting through the often repeated FUD that the XRPL is a centralized ledger, but as journalists regularly fall for and repeat these lies, it wouldn’t surprise me if some of the regulators also held this erroneous belief. The danger for cryptocurrency investors is that the governments and their central banks opt for a cooperative mechanism that swaps CBDCs directly without the need for an intermediary asset like XRP or Stellar. This seems to be what Jonathan Dharmapalan from eCurrency was suggesting during the IMF’s Cross-Border Payments—A New Beginning panel.
“Ultimately, for that cross-border space to be a safe space, Central banks have to participate. We can argue as to how they participate, but there has to be some common medium across which this takes place, and the common medium is not a private sector company – Facebook, showing up and saying we will be the common medium. The common medium has to be a common medium that hasn’t been hijacked by the private sector. And that’s really what we are talking about, and how can central banks allow that common medium to exist, but still allow private sector participants to operate across that common medium. The internet is a tricky subject because people throw the internet out as the way the future of CBDCs should work. But actually, even on the internet there are some common mediums that are centrally accepted, and the private companies don’t get to run off with it.”
“The conversation recognizes that central banks and central bank digital currencies are soon going to become a reality, and when that happens, how does cross-border work? And I believe that the participation of central banks will actually eliminate the exposure and the risks associated with cross border. And in the digital world could actually iron out some of the challenges we have with cross border payments.”
Denelle Dixon from Stellar responded to these statements with this:
“You’re comparing this to Libra, which is a very different thing than what we’re trying to focus on. Permissionless networks are the infrastructure layer that allows entities to build on top of them and innovate and to create awesome ideas and to create products that will solve these problems that folks have all over the world. They’re gonna solve financial inclusion because you can do it on your phone, you can make it so people don’t have to have bank accounts. The comparison with the internet is that infrastructure layer, that technology layer. The notion that AML and all of the different regulations need to apply here is absolutely agreed upon. And those financial institutions that touch fiat on the edges are regulated by all of the different geographies. We cannot forget that that is the important piece of this, that is what creates the interoperability that is what makes it so that this all works seamlessly.”
And Rory MacFarquhar of Mastercard argued that the lack of trust between central-banks and nation-states was not likely to evaporate in the foreseeable future:
“Building cross border structures among governments requires a lot of trust among those governments. And we’re not necessarily at a moment in geopolitical history where there’s universal trust.”
While Bitcoin, Stellar, Etherum, and XRP are not fundamentally controlled by a private company like Libra is, there are still problems with aspects of these technologies, like mining being controlled by Chinese mining pools or organizations and individuals who are responsible for the majority of the development work on a decentralized network being located within range of the coercive mechanisms of the United States. To call these technologies completely independent is somewhat misleading. And labeling them as infrastructure akin to the internet is premature.
As Denelle Dixon indicated, we may well see CBDCs issued on open, permissionless networks like Stellar, XRPL, or Ethereum, but it seems equally likely that central banks would go a different route should they decide to tokenize their currencies. Giving control of a CBDC to the governance protocols of a decentralized network, with all of the things that we’ve already seen go wrong with governance on these chains, makes it unlikely that a nation-state would ever place its currency onto the back of such a historically unstable structure that it has no direct control over. Independent cryptocurrencies as an intermediary asset, swapped between CBDCs seem like the most likely scenario, but it is by no means guaranteed.
Some of the regulatory floundering can also be explained by the fact that blockchains are extranational entities, with their own governance models and traditions that operate outside of, but intersect with, the physical space. They hop jurisdictions and cross borders seamlessly, piggybacking off of the internet’s infrastructure. They resemble mesh networks of the kind found in authoritarian states where citizens set up a decentralized local network by peering wireless routers together, which allows them to bypass the government’s physical control over their local internet infrastructure. While these technologies can be shut down temporarily, it is almost impossible to destroy them entirely. If we look at dark web marketplaces, for each one shut down, another springs up to take its place. It’s very difficult, even for nation-states as powerful as the United States, to suppress a technology once it’s escaped amongst the general public.
Then there is the question of whether a neutral settlement asset or the existence of several viable alternatives could dilute the dollar’s international power projection capabilities. David Schwartz mentioned this possibility in a string of recent Twitter threads:
Schwartz also posted notes for an upcoming Berkeley speech on CBDCs, the unlikely possibility of a one-world currency, and the need for interoperability for international payment infrastructure. He had this to say about CBDCs and reserve currencies:
“I don’t think the USD being fully replaced as the world’s reserve currency is likely in the near term, or even over the next few decades. But its position is becoming more precarious because of several reasons: pandemic uncertainty forcing consumers and institutions to look at other safe haven asset classes (like crypto) and the rise of other countries (particularly China) that are trying to dethrone USD. Being tied to USD also brings jurisdictional ties as well that are, let’s be realistic, increasingly unwanted in many parts of the world. Today, many sovereign countries around the world want independence from a system that gives jurisdictions like the US and the EU extraterritorial control over systems in those sovereign countries and their regions. Saudi Arabia, for example, wants a payment system in the middle east that respects their sovereignty.
If each country issues their own CBDC or starts using stablecoins denominated in different regional currencies, we risk repeating this mistake yet again. We drastically need interoperability between these virtual currencies and between virtual currencies and traditional assets and systems. A CBDC by definition will carry the same capital controls, trade agreements, politics, etc., just as its corresponding fiat currency did. Again, countries are not going to want to deal with another country’s capital controls.”
I wonder if some of the regulatory hesitancy in the United States has to do with the potential of the blockchain to supplant or even simply dilute the dollar’s role as the global reserve currency. Schwartz indicated that this wasn’t likely for a few decades, but he seems to think that the potential is there for digital assets to do this. In a recent Coindesk article, Steven McKie stated that digital currencies, while they may seem to be drains on state power, might instead be a boon to diplomacy and international business:
“In essence, though these systems may at first seem adversarial to state power by their very design, if you look more closely, you’ll see they inherently (slowly) improve diplomacy via scalable trustless cooperation and international business over time.”
That statement on scalable trustless cooperation being desirable seems reasonable for powers that are not in possession of the global reserve currency. Cryptocurrency models like Stellar, XRP, or any of the other numerous efficient digital assets that could be used as an intermediary asset or even a currency itself, are probably appealing to nation-states that are forced to operate within the currency power projection capabilities the United States, as these models would be freeing to them. But the Americans are probably hesitant to run towards decentralized currency models with open arms as they have the potential to dilute their power. Getting regulations “right” in this case could mean trying to find a way to digitize currency and facilitate blockchain commerce activities in a way that preserves American power. If this is the case, companies like Ripple need to do their best to convince American power structures that their independent ledgers are a boon to American geopolitical goals. If they cannot do that, it’s likely that they could find themselves stuck in regulatory limbo for as long as it takes for the mechanisms of the American state to figure out what to do with the technological hydra that is the blockchain. These factors may be the reason that Ripple has been recently toying with moving to greener pastures.
McKie also suggested that Bitcoin likely wouldn’t represent a threat to state power as it behaves more like gold than like a state-backed currency.
“Bitcoin, in this respect, is very much like gold. And like gold, it poses no active threat to state currencies or state power. For the value of state currencies – as described above – is predicated upon the actual, practical power of states. Throughout modern history, the preeminent reserve currency has been the coin of the world’s preeminent military power. Only if states lose their status as the main global powers are their currencies likely to follow suit.”
This somewhat explains the greenlight given to Bitcoin and Ethereum, but Bitcoin being digital gold is somewhat of a stretch. And considering that we have American law enforcement agencies clearly signaling that Bitcoin and Ethereum are widely used to bypass American Sanctions by adversary nation-states as well as criminal organizations, the gold reasoning, even if true, doesn’t quite alleviate the contradictory nature of current regulations in the United States. If BTC and ETH are already being used to circumvent American currency controls, and they have been used in this manner even before they were given the regulatory go-ahead, why now disallow a multitude of other viable digital assets for fear of something similar occurring?
Further confounding the issue is a statement by the Trump administration found on Breitbart blasting the SEC chairman, Jay Clayton, for dragging his feet on digital currency regulations.
“The president has rightly identified China as our geopolitical foe and has smartly maneuvered to thwart their aggression through his trade negotiations, his rebuilding of the military, and his overall economic plan,” a senior administration official said.
So when you look toward the future, digital currency is going to be a major front in the broader economic battle. We need to make sure the SEC is not putting American companies at a disadvantage because China is making a major play in the crypto-space.”
These comments echo similar statements released earlier by the Trump administration:
While these comments are positive indicators towards greater regulatory clarity, the Trump administration facing the possibility of defeat in the upcoming presidential elections resurrects the issue as there’s no indication that Biden feels the same way about the SEC’s regulatory foot-dragging. The cause of the floundering seems to be a fusion of incumbents protecting their own economic interests, geopolitical concerns, and good old-fashioned incompetence. Whether these regulatory issues drag on or are fixed by upcoming bill propositions like the Digital Commodity Exchange Act of 2020 or a decree by a re-elected Trump administration is impossible to predict.
If you have any additional thoughts or questions, don’t hesitate to reach out on Twitter @MacroPolo707.