Cryptocurrencies need more than Russia sanctions to beat US dollar hegemony

Cryptocurrency enthusiasts are pushing digital currencies as a viable alternative amid Russia’s search for ways to navigate Western sanctions
Efforts to move cryptocurrencies into the mainstream are doomed, though, as long as their many practical problems remain unresolved

Chee Yik-wai

Published: 1:30am, 30 Mar 2022

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One of the unintended consequences from the war in Ukraine could be the undermining of US dollar status as the global reserve currency. As sanctions on Russia get tougher, leading to most Russian banks being cut off from the global financial system, some countries could contemplate a geopolitical alternative to the dollar.

Some financial analysts have again floated the advantages of a decentralised cryptocurrency such as bitcoin, currently valued at around US$47,000. The likes of Ray Dalio, former Twitter CEO Jack Dorsey and Tesla CEO Elon Musk have all been bullish on bitcoin’s future amid rising US inflation.

Many governments have taken measures to restrict bitcoin’s use within their borders, though, with El Salvador the only country to accept bitcoin as legal tender. So, how realistic is the prospect of decentralised cryptocurrencies replacing the US dollar despite the ongoing global financial volatility?

Numerous cryptocurrency enthusiasts seem to believe that fiat currencies, especially the US dollar, are created out of thin air but overlook the complicated financial institutional mechanisms behind it. The Federal Reserve, like any other country’s central bank, makes loans to banks against collateral to create new currency backed by these loans.

Banks typically have more assets – in the form of loans, securities and cash – than liabilities, which include the deposits of their customers.

In essence, central banks’ liabilities are all the money they create through loans to banks. Their assets are all their loans and bonds. All money generated is covered by assets, which does not apply to cryptocurrencies.

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In an overheating economy burdened with high inflation, central banks tend to balance things out and exert their influence through interest rate adjustments.

Most central banks in functioning economies are also largely independent of politicians. Cryptocurrency proponents believe in its ability to replace cash because of its cheaper, more decentralised nature.

However, popular cryptocurrencies such as bitcoin and ethereum would no longer be cheap compared to fiat currencies, given their high prices. Their price needs to be much lower and more stable to be seriously considered for universal adoption, and this would not be popular among investors.

Currency creation is unquestionably a state monopoly. Legislation defines what qualifies as legal tender to settle debts, pay taxes, and so on. Citizens creating their own currency and keeping the profits face prosecution. In China, the charge of conducting a “large amount” of cryptocurrency fundraising carries a prison sentence of up to 10 years.

Governments can ban alternative currencies and limit their usage to the black market. In 1933, the US government forced holders of gold bullion to exchange the gold for banknotes, and made holding large amounts of gold illegal.

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Most governments have yet to understand the need to act decisively in the face of the strength of the cryptocurrency movement. US President Joe Biden’s administration has started paving the way for the United States to study its impact.

Some cryptocurrency supporters point to states such as Venezuela to highlight the failures of fiat currencies. This defies logic, though, as fiat currencies have little to do with economic collapse, which is often a result of catastrophic economic policies.

Governments will continue to adjust their monetary policies and money supply to support their policies. These goals and policies will not change to conform to an arbitrary definition of money.

Some argue that cryptocurrencies’ decentralised nature makes them an exception. This neglects governments’ ability to make it difficult to use them and seize them if necessary.

Fiat currencies will continue to dominate as long as there are nation states and governments that are powerful enough to enforce their laws. Cryptocurrencies might become cheaper to transmit in time, and easier to use, but the lack of legal recognition means there will be no fraud protection.

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How could we recover our money if a retailer went broke or failed to deliver the merchandise we paid for with cryptocurrencies? What would happen if we lost our private digital keys or passwords? How could loans be made with cryptocurrencies to expand the increasingly debt-based economy?

Bitcoin has experienced dramatic fluctuations throughout its existence. Can we really accept volatility akin to the Turkish lira in something used for everyday payments?

Cryptocurrency proponents say things will improve over time, but that is also true for alternative fiat currency-based transaction systems. Governments are already exploring the use of central bank digital currencies, which embody the best features of cryptocurrencies with none of their shortcomings.

To understand the obstacles to decentralised cryptocurrencies being mainstream, look no further than the fundamental reasons governments prefer fiat currencies and why competitors such as gold ultimately failed to meet the modern world’s demands.

Fiat currencies allow central banks to adjust the currency supply in circulation to meet liquidity needs. While far from perfect, it reduces the risk of volatility and economic uncertainty.

Investors should remember cryptocurrencies are merely a digital asset in their current form. Most only love them for their potential to make them rich – ironically enough, in fiat currencies.

We might never see their use in everyday life if they cannot provide more advantages than fiat currencies enjoy. Before the practical problems of decentralised cryptocurrencies are resolved, we should approach them with caution and a healthy dose of scepticism.

Chee Yik-wai is a Malaysia-based intercultural specialist and the co-founder of Crowdsukan, focusing on sport diplomacy for peace and development.