Thoughts on Geopolitics and Cryptocurrency

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Last month, the cryptocurrency exchange FTX collapsed in epic fashion. As recently as January, FTX was valued at a reported $32 billion. Now, it is bankrupt. To put that into context, that would be like the GDP of Cyprus evaporating overnight. The destruction of that much capital is not just a crypto issue, or a Bahamas issue (where FTX was/is based) – it is a global issue.

To be clear: I am not an expert on cryptocurrencies and have no desire to use this piece to argue for or against them. I do, however, think this is a key moment where cryptocurrencies and geopolitics are about to clash head-on, and to that end I think I can frame a differentiated perspective on what will happen next.

Indeed, it has become impossible to ignore cryptocurrencies now as a global issue. They have become geopolitically significant. El Salvador, for instance – a country that eliminated its own currency, the colón, in 2001 and replaced it with the U.S. dollar – has in recent years bet heavily on bitcoin, making it legal tender in the country and even buying bitcoins (a bet that is looking increasingly bad as the price of bitcoin has swooned in recent months). The International Monetary Fund has expressed concern that El Salvador’s exposure to bitcoin will end badly, but El Salvador’s controversial President, Nayib Bukele, does not care – he is “buying the dip.”

Since the integration of the global economy began to accelerate markedly around the time of the Industrial Revolution, there has been a need to have a universal means of exchange. For centuries, various national currencies – the Dutch guilder, the French franc, and the pound sterling – served that purpose. These currencies, however, were valued in reference to precious metals. Silver was used as the standard economic unit of account until the 19th century, when the United Kingdom – whose pound sterling rose after the ignominious collapse of Napoleon – instituted a gold standard in 1821.

The gold standard continued to dominate global finance with occasional hiccups due to war and conflict until August 1971, when then U.S. President Richard Nixon ended the convertibility of U.S. dollars into gold and inaugurated the era of fiat currency. Fiat money is government-issued currency whose value is not defined in reference to a commodity like silver or gold but instead by market forces. There is a finite amount of silver and gold in the world – but tying the value of a currency to a metal in the ground was always somewhat arbitrary, even if the finiteness of precious metals protected a currency’s value.

Fiat money was better for central banks, as it gave them more control over the economy because they could control how much money was printed. This came with both pros and cons. Fiat money allows governments and central banks to be more flexible and strategic – they can design policies around interest rates and money supply without being dependent on what mining companies can extract from the ground. The downside of this is that money, whose value for so long had been based on an objective factor (the value of a precious metal), was now officially politicized.

Distrust of governments – i.e., of human beings – is what drove the silver and gold standards and continues to drive investment in these precious metals today, the idea being that the value of currencies can fluctuate based on the proclivities of politicians, while the price of a precious metal is more impervious to manipulation. It is also the driving force behind “cryptocurrency,” which in practical terms is simply an economic unit of account based on a finite supply of a virtual resource. That is why cryptocurrencies, and bitcoin in particular, are often described as “digital gold.”

The technology behind cryptocurrencies is blockchain. Blockchain is a distributed ledger technology that contains lists of records (referred to as blocks) which are securely linked together. Blockchain allows a currency to become decentralized – transactions are validated by individual nodes in the system rather than being defined by a central bank or singular reference point. You do not have to be a technological maven to understand the implications of blockchain technology applied to currencies – the idea is to return to something akin to the gold standard, where the value of currencies are not set by central banks but by markets.

This, by the way, is what makes the FTX drama ironic. In a fully decentralized world, where cryptocurrencies replace fiat money, there is theoretically no need for a cryptocurrency exchange. FTX was essentially an unregulated space where people without enough tech literacy or concern could buy and sell cryptocurrencies without worrying about custody, digital wallets, and the technological backend that makes cryptocurrencies possible. Cryptocurrency enthusiasts will be the first to tell you that FTX is a perfect example for why cryptocurrencies are needed – Sam Bankman-Fried is a perfect example of human infallibility, and even nefariousness.?

It should be obvious by this point what all of this has to do with geopolitics. The FTX melodrama is interesting and arguably even important on a certain level – but it is ultimately a contained issue, and not one that will have significant global impacts, even if FTX was big enough to create a ripple in the global economy. The bigger issue at play with cryptocurrencies is that for the first time in modern history, currencies issued by national governments have a challenger.

At a grassroots level, people distrust their government institutions and central banks, believing (with good reason) that the system is rigged against them, that it rewards large entities to the detriment of individuals, and that governments are simply printing more money – leading to inflation and debasement of currency values – in a vain attempt to repurchase the trust in the system that has already been lost. Central banks can continue to print more and more money, but eventually, debts will have to be forgiven, or we could experience the kind of hyperinflation that heretofore only happened in fundamentally sick economies (like post-WWI Germany, or Venezuela today).

Cryptocurrencies also aspire to be more than just currencies. Bitcoin was the first-mover, and with the exception of El Salvador behaves largely like a store of value, not as a currency. (I could not come to the streets of Rome and offer to pay for an espresso with bitcoin in most places, for instance.) But “next-generation” cryptocurrencies, like Ethereum, or Cardano’s ADA, promise something even more threatening to traditional finance. Theoretically, blockchain can be used to transmit data of any kind, from medical records to contracts. And that is exactly the sort of decentralized future cryptocurrency supporters have in mind.

If you have ever tried to wire cash from one country to another, or even tried to pay someone a large sum of money in your own currency, you will know how inefficient the system currently is. Networks of banks and financial services companies charge fees to make sure your money gets from point A to point B. Decentralized finance eliminates these companies, because each individual can transmit money to another individual on the ledger at any time, without fees or any sort of middleman. The true potential of cryptocurrency envisions the elimination of most traditional financial institutions – ironically, including exchanges like FTX – in favor of each individual acting as their own bank, or their own exchange.??

With “smart contracts,” you can theoretically take this even further. A contract can be agreed to for services rendered, and when objective benchmarks related to the fulfillment of the contract are reached, a transfer of money from one individual to another can happen automatically – without an individual being able to withhold payment for any reason. The contradiction at the heart of cryptocurrency is that it aims to empower the individual even as it completely distrusts the individual. Coded rules hardwired into cryptocurrency create that trust – and in a crypto-optimist’s view, create a currency with far more security than a national issued fiat currency, which is ultimately subject to the decisions of individual officials whether elected or not.?

The real question, then, about cryptocurrency, is not about the wildly fluctuating value of bitcoin, or even the collapse of a company like FTX. Cryptocurrency’s future will be decided by whether people decide to use it as a currency – as a primary means of exchange. This would mean a large enough group of people eschewing their national currencies or the U.S. dollar for currencies not controlled by a sovereign entity. So far, things are not going so well in El Salvador, where both the dollar and bitcoin are technically legal tender. Only 20 percent of firms reportedly accept bitcoin, and only 20 percent of survey responded indicated they kept using their government-issued digital wallet after collecting a $30 bonus for downloading the app (which in and of itself has FTX vibes – why do you need a government-issued digital wallet for a currency whose entire point is moving away from governments?).

The appeal of cryptocurrency is most attractive today to those living in authoritarian regimes, where national currencies are mistrusted, or by shadowy actors that for whatever reason wish to fly below the radar of most governments, whether to avoid sanctions or trade in illicit goods like drugs or weapons. In the long-term, national governments will view cryptocurrencies as a threat, especially if they are adopted in increasing numbers by the people those governments rule – even if those governments are democracies.

We have already seen this happen in some countries. China has banned cryptocurrencies, as have countries like Algeria, Bangladesh, Egypt, Nepal, and Tunisia. India briefly flirted with a cryptocurrency ban but reversed course even as top Indian government officials believe they should be prohibited. Iran allows cryptocurrency for imports, but has had to impose restrictions on energy-intensive crypto-miners, who have pulled so much electricity from the grid as to cause blackouts in entire Iranian cities. ?

A crypto-optimist would point out that governments cannot control cryptocurrencies – that is the whole point. Governments can ban cryptocurrencies if they like, but they cannot stop individuals from using them. That is, technically speaking, true – but do not underestimate the power of governments, especially when they face a challenge as novel and revolutionary as crypto. Controlling money supply is not just one of government’s most important functions – it is a primary source of government power, and no government will consent to give up that power unless, like El Salvador, it was already forced to do so for unavoidable economic reasons.

In that sense, FTX may well be the beginning of the long-awaited clash between cryptocurrencies and governments – not because FTX is in any way representative of cryptocurrencies, but because it gives governments the excuse they need to crack down on them. It is unclear how many people lost money, or even their life savings, in the FTX debacle (an issue to societal stability in its own right), but you can be sure governments will use the FTX example as they aim to regulate cryptocurrencies into oblivion – or at least into becoming similar to other tradeable securities rather than as a fundamental threat to the future of money.

Max Weber once wrote that the state is defined in part by its claim to the monopoly on the legitimate use of physical force. I think we can add that the state claims a monopoly on the legitimate use of currencies within its borders. When the state decides to use the former to ensure the latter, we will see just how powerful cryptocurrency really is – and based on recent developments, it is a clash soon in the making.