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During the first half of June 2023, two major events rocked cryptocurrency markets. First, the US Securities and Exchange Commission (SEC) filed lawsuits against two crypto exchanges, Coinbase and Binance, with charges that included operation of an unregistered exchange, brokerage, and clearinghouse. Crypto prices tumbled on the news. Second, BlackRock, the world’s largest asset manager, filed an application with the SEC to start up a Bitcoin ETF (exchange traded fund). A few weeks later, in early July, BlackRock CEO Larry Fink made a series of public statements in which he likened Bitcoin and crypto more generally to “digital gold” and further noted that Bitcoin would “revolutionize finance”. In the wake of these statements, crypto users on social media and in the financial presses got really excited and bullish on Bitcoin. As Forbes India put it, “Fink's remarks were met with positive reactions from crypto users on social media, with some speculating that his statements could trigger a surge in asset prices, dubbing it the "Fink Pump." My impression was that many were relieved to see crypto rescued by BlackRock from the regulatory troubles that had soured the market’s mood in the weeks prior.
My own interpretation of these events is rather different from the reports and commentaries I’ve seen so far, most of which focused on the future of crypto as if the market somehow exists in a financial vacuum immune from broader geopolitical forces. The US dollar is in real trouble and cryptocurrency markets are an important front in the ongoing economic war over the dollar’s future. Recent moves by the US SEC and major US financial institutions to regulate and invest in crypto are best understood as a single, cohesive set of measures to gain more control over a wild and freewheeling marketplace that poses an existential threat to the US dollar.
US government regulators and private financial institutions have a mutual interest in managing and diminishing the threat posed to the dollar by crypto. As economist Gerald Epstein recently noted, “The fact of the matter is that having the dollar as the world’s key currency gives the U.S. government significant power to call the shots financially in the global economy; it gives a leg up to U.S. financial institutions in the global economy because they have easy access to U.S. dollars from the Federal Reserve; and it makes it easier to finance the massive U.S. budget deficit and foreign borrowing.”
A caveat. This analysis is partly speculative. All the data are not in, events are not wholly clear, and there are a lot of missing pieces. I’ll keep you updated, and make revisions, as the situation changes.
The Open Economy Trilemma
In open economy macroeconomics, the “open economy trilemma” (a.k.a. the “unholy trinity”) describes the tradeoffs policymakers face in deciding which goals to pursue and how to balance them. The trilemma is the general framework I’ve been using to think about cryptocurrency these days. In general, it means that policymakers can choose only TWO of the following three economic "goods":
1. International capital mobility: The ability of domestic entities to borrow and invest abroad, and the ability of foreign entities to borrow and invest domestically.
2. Exchange rate stability: Maintaining a relatively stable relationship between the value of the domestic currency and that of foreign currencies.
3. Monetary/fiscal policy autonomy: The ability to freely increase/decrease the money supply (i.e., increase/decrease interest rates) and/or increase/decrease government spending to meet national economic goals.
If international capital mobility—i.e., open capital markets that freely permit financial flows across national borders—is deemed important, and then a government decides to, say, print money in order to bail out some struggling banks, then it can expect the exchange rate to depreciate as the currency is devalued and investors take their money out of that economy and put it somewhere else.
If instead the government values exchange rate stability, perhaps because it is reliant on imports and a depreciating exchange rate will create balance of payments problems and inflation, then in order to print money to bail out those banks, it will have to limit cross-border capital mobility. Historically, instruments to do this include various forms of "capital controls", like suspensions of currency convertibility or other regulations that limit or block capital outflows. (Like most people, capital generally likes to be safe, so it “flees”, leaves for another jurisdiction, when staying put becomes too costly).
While all but one of the world’s governments have for decades struggled with this thorny set of policy trade-offs, the US has uniquely been able to avoid them because the dollar has, up to this point, been the world's reserve currency. It didn't really matter what kinds of policy decisions the US made, demand for the dollar stayed relatively high and stable because of how widely used the dollar is in international trade and finance. Other countries needed dollars a lot, no matter what US monetary policy looked like. But, as the dollar's dominance wanes, the banking crisis drags on, and government debts piles up, the US will increasingly be required to make the same tough decisions other countries have to.
One ways the US is trying to fight its way out of the trilemma’s bind is by “blocking the exits”, so to speak, trying to prevent future capital flight by undermining the dollar’s competitors. One of the things I find especially interesting is that, in crypto’s case, US regulators and financial institutions seem to be using tools and methods that don’t really look much like traditional capital controls at all but which nonetheless seem to be playing the same, or a similar, role. (Crypto is not the only exit the US is trying to block, either, but I’ll leave that for a different article.)
The Threat Posed by Crypto
Crypto was originally and explicitly designed to provide a viable alternative to financial networks and currencies governed by central banks and financial institutions. In 2008, Satoshi Nakamoto (a pseudonym), published the now-famous “Bitcoin white paper” in which the idea for the first-ever cryptocurrency was developed and shared with the world. Nakamoto’s vision—one that helped to initially popularize Bitcoin especially among smaller and anti-establishment investors—was one of an independent and decentralized digital payments system, one that was detached and immune from surveillance, speculation, and market manipulation by big financial firms and government central banks. Nakamoto’s white paper frames Bitcoin explicitly as an alternative to “trust-based” online payments systems in which monies were funneled through a third-party intermediary:
“Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model… What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”
Writing for the crypto news service CoinDesk, Ollie Leech crucially notes the context in which the white paper was published—the 2007 US mortgage crisis which turned into the 2008 Great Recession—and why the ideas it contained were so immediately appealing to critics of the formal financial system. Note especially the emphasis on privacy and censorship and, relatedly, on independence and decentralization.
“[T]he Bitcoin white paper was the first document to outline the principles of a cryptographically secured, trustless, peer-to-peer electronic payment system that was fundamentally designed to be transparent and censorship-resistant, as well as put financial control back in the hands of the individual. At that time, the world was gripped by a financial crisis catalyzed by excessive speculation in the financial markets and banks risking millions of dollars worth of depositors' money.”
Investors who did not trust the Federal Reserve and other government agencies, and did not trust banks like Goldman Sachs or asset managers like BlackRock, turned instead to crypto, first in a trickle and then in droves, seeking out ways to transact, save, invest, and profit that did not involve playing in the same pool with institutions they saw as greedy, reckless, manipulative, fraudulent, and corrupt. The markets were wild and unruly, most mainstream observers thought, and unlikely to get too big. In 2017, for example, BlackRock’s Fink dismissed crypto markets, arguing they were too “speculative”, and in 2018 further noted that none of BlackRock’s clients were “seeking out” crypto exposure.
But the markets kept growing anyway, both in size and technological sophistication. And, critically, observers began to loudly tout crypto, especially Bitcoin, as a viable alternative to the US dollar. For example, in January 2021—the same month Bitcoin traded for over US$30,000 for the first time ever and one month before the Bitcoin market reached a US$ 1 trillion market capitalization—former Canadian Prime Minister Stephen Harper argued publicly that Bitcoin was a likely candidate to replace the US dollar (the first regulated Canadian crypto exchange opened later that year).
Other commentators rightly situated Bitcoin in geopolitical context, amidst the growing US-China rivalry, arguing that crypto was a way out of a serious international political conundrum: “For most countries, including India, it’s not clear there are any benefits to replacing the King Dollar with the King Yuan. Essentially, we’re at a stalemate. But there is an alternative that could garner global consensus”, wrote Vashesh Raisinghani in April 2021 in Seeking Alpha. “A politically-neutral asset that is more convenient than the U.S. dollar could end this stalemate”, he continued, referring to Bitcoin.
The geopolitical-financial predicament faced by foreign investors and governments in the currency arena grew even starker and more intense after the Ukraine war began in February 2022. The US and EU imposed sanctions on Russia and cut it out of the SWIFT network for dollar payments, inducing a mad scramble for alternative currencies and non-dollar payment systems that would help circumvent the sanctions regime and permit trade with Russia to continue (i.e., this is the push for “de-dollarization” I’ve written about previously). By December 2022, a few months before the US banking system was rocked by a run on Silicon Valley Bank, the Center for Strategic and International Studies (CSIS), a US-based think tank, warned about the use of crypto to evade Western sanctions and undermine the US dollar:
A current risk in today’s trade ecosystem is that countries leverage cryptocurrencies to circumvent U.S. sanctions. Cryptocurrencies are digital currencies that are not backed by central banks and are also traded outside the international banking system. In crypto transactions, individuals’ accounts, or wallets, are encrypted through alphanumeric aliases and are validated by a decentralized network of users, rather than financial intermediaries. Due to their deregulated and decentralized nature, cryptocurrencies can be a useful tool to circumvent the global domain of the dollar.
Indeed. Just last month, Russia’s Rosbank launched an independent, cross-border cryptocurrency payment system specifically designed to facilitate non-dollar trade.
Blocking the Exit
So, the dollar is in trouble, currently facing multiple threats from many quarters. Internally, the US is managing persistent inflation, an ongoing banking crisis, a commercial real estate crisis, and a debt crisis. Add to this increasingly fierce competition with China and massive self-inflicted wounds from the Ukraine war and Russia sanctions, which have induced concerted and cooperative efforts among non-Western countries to de-dollarize. This is the context within which I’m arguing we should understand the SEC’s and BlackRock’s recent moves in crypto markets—as part of the global Currency Wars—with entities in the US trying to defend the dollar against this multi-dimensional, multipolar onslaught. Seen from this vantage point, both the SEC’s regulatory crackdown and BlackRock’s Bitcoin invasion appear as tactical maneuvers to bring cryptocurrency markets into the “global domain of the dollar”, to tame them, domesticate them, control them, limiting the damage crypto can do to the dollar in the future.
Binance and Coinbase, the exchanges targeted by SEC lawsuits, are the two largest cryptocurrency exchanges in the world. Yet, many observers seem to have overlooked or dismissed what I see as a critical piece of the Currency War puzzle. The SEC lawsuit resulted in a suspension of all dollar transactions on the company’s US exchange. According to the Financial Times on June 9, “Binance US said in a statement on Friday morning that dollar dealing via banks and other payment partners would be paused as early as June 13, and from next week it would start to delist trading pairs involving the US currency. The company added it would transition to a crypto-only exchange.”
I have had a hard time finding any follow-up media coverage to these reports from early June, though the Binance US website does not appear to be permitting transactions in dollars at this time. Binance, the global exchange and parent of Binance US, suspended dollar transactions for non-US residents back in February, citing a change in policy with a partner bank. I will provide an update if and when I learn more. For the moment, though, this looks an awful lot like a suspension of dollar-crypto convertibility in the US branch of the world’s largest crypto exchange (whether or not Binance did indeed violate US law is another matter entirely).
At the same time that the SEC moved on the two exchanges, BlackRock made more big moves in the Bitcoin market. Bitcoin is the world’s most popular and widely traded cryptocurrency. A couple of years ago, BlackRock, Vanguard, and Fidelity acquired stakes in several high-profile Bitcoin mining operations, giving them some influence and control over the Bitcoin production process (see here for more info on the mining process). Last year, during the “crypto winter” which saw multiple firms (e.g., FTX) collapse and crypto prices fall, Forbes reported that “two of the world's largest financial institutions with a combined $14 trillion in assets under management—Fidelity and BlackRock” were “quietly expanding into the world of bitcoin, ethereum and cryptocurrency”, taking advantage of low crypto prices to seize market share. Also in February 2022, sources told Market Realist that BlackRock was preparing to offer Bitcoin and other crypto trading services: “The investment manager will reportedly offer “client support trading” and follow up with “their own credit facility.” The report also noted that “BlackRock owns a 5.53 percent stake in Michael Saylor-led MicroStrategy, which owns the largest amount of BTC of any company. BlackRock is MicroStrategy’s largest shareholder.”
Then, last month and right after the SEC lawsuits were handed down, BlackRock filed its ETF application with the US Securities and Exchange Commission (SEC). An ETF is a “pooled investment security that holds multiple underlying assets” and they can track and give investors exposure to indexes, sectors, industries, commodities, securities, and bonds. Unlike futures ETFs, spot ETFs actually require the issuer to hold the underlying commodity or security in reserve to back the shares issued. The application thus implies that BlackRock has already acquired substantial Bitcoin holdings, though exact figures have been difficult to locate (it seems that BlackRock is playing its cards tight to the vest here).
The SEC has not approved the proposal yet, but most observers seem to expect that it will do so soon, especially since news broke that BlackRock, along with Nasdaq and Coinbase, has proposed a rigorous surveillance mechanism that is likely to please regulators. According to Reuters,
The SEC has previously rejected dozens of spot bitcoin ETF applications, saying the proposals did not meet anti-fraud and investor protection standards.
But Nasdaq—where BlackRock proposed to list its ETF—said earlier this month that it would address those concerns by working with Coinbase, the largest U.S.-based crypto exchange, to police trading in the underlying bitcoin market. Similar filings from CBOE Global Markets also proposed a similar surveillance arrangement.
BlackRock—which has assets under management that exceed the value of assets held by the US Federal Reserve and which are also larger than the 2022 GDP of every country on earth except for the US and China—is in this way positioning itself to utterly dominate the crypto marketplace, with solid footholds apparently already (or about to be) established in production, investment, trading, and crypto-based securities. In terms of the Currency Wars, it would seem that these moves likely accomplishes several strategic goals for a firm like BlackRock: a. helping them capture market share and profit in a growing and popular marketplace they were slow to initially embrace; b. permitting them influence over crypto prices (by extension, this means influence over various dollar-crypto exchange rates and rates of return for cryptocurrencies relative to other assets); and, c. further allowing them to surveille, monitor, report, and potentially limit/block crypto transactions and flows, assisting regulators as the government assumes more of a “police” presence in the marketplace.
Taken together and depending on how they evolve and are deployed and leveraged moving forward, these advantages could, in theory, help major financial firms like BlackRock work with regulators to co-opt crypto, to bring cryptocurrencies squarely into orbit around the US dollar, tethering them to the US system such that crypto trading complements and reinforces dollar dominance rather than competing with it.
I could imagine a future Bitcoin market in which large quantities of Bitcoin are owned by BlackRock, Vanguard, and Fidelity, in which these firms have a large equity stake in all the large mining companies, in which they also work as partner with the exchanges on which Bitcoin and related securities are traded, in which they further intermediate most of the Bitcoin trades, and in which they additionally work closely with regulators to police the marketplace. It wouldn’t look all that different from other heavily financialized and monopolized markets I’ve studied, from oil and gold to coffee and broiler chickens.
Whether the US will be victorious on this particular front in the Currency Wars remains to be seen, but the SEC and BlackRock have thrown down and let loose one heck of a battle cry.