Governments have a complicated relationship with cryptocurrencies. Some governments tolerate crypto, albeit begrudgingly, and step in only to mitigate the most egregious instances of fraud or abuse. Other governments have significantly lower tolerance for these new instruments and work to eradicate them from their domestic economies, roots and all. Yet other governments don’t just tolerate cryptocurrencies, but they also embrace it, sometimes creating regulatory sandboxes and, in well-known cases, legalizing cryptocurrencies like Bitcoin as a formal national currency.
Some may dismiss this variation in hostility as only an issue for cryptocurrency traders; this is a mistake. The causes of government perspectives and choices about cryptocurrencies matter for reasons beyond Bitcoin price volatility. In fact, there are three ways of thinking about how governments perceive and act on cryptocurrencies which situate these issues in a much larger framework than noisy nascent markets. These include cryptocurrency as a distraction from traditional investment markets, as competition for the role of fiat money, and as a negotiation tool under the auspices of interstate relations. Each of these approaches, as I argue below, not only help to explain the difference in behavior between countries that span these divides; these frameworks also help to project the likely future of global cryptocurrency markets in general.
i. Cryptocurrency as Distraction
Cryptocurrency markets are known for extreme price volatility. While this means many investors lose significant sums on these new markets, it also implies that some investors win significantly higher returns on investment than in other financial markets. In many cases this is not a sufficient issue to affect state preferences on cryptocurrencies, though in other cases it is a clear primary cause of countries’ regulatory reactions in this space. The clearest example among these is South Korea and China, for two distinct reasons.
In South Korea, cryptocurrency speculation became wildly popular very quickly, not only among younger generations but across the population more generally. Reasons for the popularity of retail cryptocurrency investing in the country range from chronic unemployment among its young people, to a long familiarity with digital asset trading dating back to 2001. Crypto is so popular in the country that South Korean investors pay up to a 23% premium due to its relative scarcity on domestically registered cryptocurrency exchanges. South Korea is also known for having some of the most robust and proactive cryptocurrency exchange regulation in the world, beginning with its 2020 pivot toward anti-money laundering compliance standards and its more recent initiatives in bespoke tax laws for the cryptocurrency sector. Notably, on the end of exchange regulations, South Korea’s increasingly tight standards are causing global ripple effects as Korean exchanges delist coins that fall into non-compliant categories in Korean law.
In China, by contrast, cryptocurrencies served for a while as a risk-on asset class which disrupted a relatively fragile investment market equilibrium in the country. The fragility of this equilibrium was due in no small part to the country’s dual strategy of hyper-concentrated market share among national champions in different sectors, and of strict and strategic capital controls to maintain a favorable exchange rate against other prevailing currencies in the global market. In contrast to South Korea’s proactive, if tight regulatory embrace of legalized cryptocurrencies, China is known for its long-standing and repeatedly enforced ban of cryptocurrency exchanges and transactions within the country. This notably different reaction to cryptocurrency as a distraction has similarly created global ripple effects as exchanges rush to remove Chinese users from apps, and the withdrawal of Chinese investment capital leading each time to generally massive market volatility with each reiteration of the regulatory ban.
Both of these cases show how a distraction to typical investment markets can yield harsh reactions from governments, either in the form of tight regulatory reactions or outright bans. Notably, in these cases, cryptocurrency shifts government interests and shapes regulatory outcomes because its primary role in those contexts is as a speculative asset. As we can see in the next two cases, reactions among other countries vary significantly when cryptocurrency plays more of a functional role as competition with existing payments or play a role in negotiation with and among non-governmental actors.
ii. Cryptocurrency as Competition
Early cryptocurrencies, like Bitcoin, were explicitly designed to unseat fiat money. In most cases, they have not been particularly successful in this mission – with some notable exceptions I discuss in the next section. However, cryptocurrencies have introduced new competition for some countries as modes of digital payments. This competition is not direct with fiat currencies, but a more indirect mode of competition with existing digital payment providers, and early inconsistency with existing regulations surrounding digital payments. Key among these are issues of anti-money laundering and know-your-customer frameworks which are not inherent to the cryptocurrency ecosystem, and in some cases, are easily subverted in cryptocurrencies.
The Caribbean offers one example of this dynamic, where chronic underbanking has left many citizens reliant on private payment providers or simple paper cash for most of their economic needs. In the Bahamas, especially, geography poses important and unique constraints to improving financial inclusion with standard retail banks. With notoriously few electronic payment providers located in the island economy, the Bahamas has worked to correct this issue by pursuing a central bank digital currency (CBDC), the Sand Dollar, designed explicitly to improve financial inclusion. Now live, the project has been designed quite intentionally around this policy priority, with the full population now able to settle retail CBDC transactions in real time.
Conversely, some Scandinavian countries exhibit the other end of currency inefficiency, with historically low and still declining rates of cash usage empowering a thriving sector of digital payment providers whose authority is challenged by more efficient solutions like cryptocurrency. Sweden is a leader in this pattern, with only about 2% of transactions occurring in cash, with the remainder processed through digital payment providers. Both in response to underlying fundamentals which have contributed to the decline in cash usage, and as a contributing cause, major digital payment firms like Swish predominate the retail payment space in Sweden. Similarly to the Bahamas, Sweden is now pursuing a CBDC, due in no small part to these increasing concerns surrounding a cashless society and the risks which arise from allowing cryptocurrency to take the lead in this transition away from paper fiat cash as a primary payment mechanism.
While the underlying economic and policy fundamentals vary significantly across cases, each exhibits evidence of how governments respond when cryptocurrencies serve as competition for existing solutions to issues of currency inefficiency. Ranging from underbanking to declining cash usage, payment providers have already established market share in private-sector corrections to these issues which cryptocurrencies potentially offer with lower costs to end-users. As a result, countries have begun to explore solutions which simultaneously shore up private sector control in these solutions and modify the existing technical design of money in ways which subvert cryptocurrencies’ solutions to those issues.
iii. Cryptocurrency as Negotiation
Finally, because cryptocurrencies serve both to divert existing investment flows and to challenge monetary authority within and across economies, countries are extremely vulnerable to other countries’ choices around crypto. This spillover dynamic, a key feature of earlier posts about CBDC design, is not only an accidental byproduct of economic interlinkages. Rather, the fact that countries’ decisions spill over across sovereign borders leaves interdependence as a potential economic weapon for countries seeking to subvert global power. Two cases are especially telling in this instance: Venezuela and El Salvador.
On one hand, Venezuela shows how a state-developed cryptocurrency – distinct from a central bank digital currency (CBDC) – can play a significant role in shaping geopolitical negotiation. Venezuela was one of the first countries to leverage this opportunity with its development of Petro, an oil-backed stablecoin designed to help the regime avoid international sanctions for human rights abuses. While many Venezuelans rely on cryptocurrencies as safe haven investments to hedge against hyperinflation, the Petro has failed to offset this tendency toward the state-sponsored instrument. This failure is seen as dually caused by the still-unknown technical specifications which pin the coin’s value to the promised underlying material assets and the generally harsh response by foreign countries – especially the United States – which has all but halted the international aspirations of the subversive project. Many pundits have seen this as detrimental both to the health of global sanctions and to the credibility of otherwise ambitious cryptocurrency projects.
On the other hand, El Salvador is a more recent case of a different strategy in this domain. Widely known for its recent legalization of Bitcoin as a national currency, many pundits have criticized the country’s decision to introduce a decentralized cryptocurrency as a legal counterpart to fiat money. Ranging from critiques of the roll-out, to arguments that the stated motivations are a farce, critics have largely framed the move as a sincere nod to Bitcoin’s origins in unseating fiat money altogether. Few, however, have recognized the critical signaling that this choice involves, and its role in El Salvador’s domestic and international political strategy. Indeed, in line with Bukele’s proclamation to be the world’s ‘coolest dictator’, the pivot to Bitcoin legalization can be understood as a tightening of his grip on domestic politics through populist appeals in a country where crypto adoption is relatively quite high. Most notably, though, is the shift that Bitcoin legalization offers for El Salvador’s global negotiating position, as it has clearly raised flags with its creditors at the IMF, with which El Salvador has critical negotiations in light of Covid economic fall-out. A credible threat to macroeconomic stability is its own bargaining chip when control of a volatile instrument lies outside of governments’ hands, and this may be the most critical aspect of El Salvador’s recent move.
iv. Conclusion: The Future of Cryptocurrency and Governments
We should cease to pretend that the technical similarities of cryptocurrencies implies similarity in governments’ receptions to the technology across borders. Rather, as I have argued here, government responses to crypto can only be understood in the context of what functional roles cryptocurrency fills within a domestic economy. Where cryptocurrency is a distraction from traditional investment markets, we have seen harsh financial asset regulations applied. Where cryptocurrency is competition with standard fiat money or existing payment processors, we have seen rapid development of government digital currencies, CBDCs, to address that market opening. Where cryptocurrency stands to disrupt domestic and international politics and economics, we have seen governments leverage it to improve their negotiating posture and subvert power structures on the global stage, especially against major powers and international institutions.
Each of these responses matters because it implicates the future of global cryptocurrency markets more generally. Not only do these tentative, and heuristic, assessments imply a pending geography of qualitatively different national cryptocurrency markets in the coming decade; they also suggest different motivations for governments and private firms to develop their own competing digital currencies, and offer clues about the pace and shape those projects will take. While cryptocurrency markets remain nascent, attention to these more political dynamics might make the difference for firms seeking to optimize their technical products and market strategies while operating across borders in a volatile and digital world.