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Thesis Summary
As Bitcoin (BTC-USD) recovers from its recent slump, the world’s premier cryptocurrency has taken centre stage in geopolitical news, as speculation over Russia’s relationship with Bitcoin has run wild.
The timing could not be more significant, as tension builds up over Ukraine, and it poses a lot of interesting questions regarding dollar hegemony, the role of Bitcoin in international politics and game theory.
Ultimately, I believe Bitcoin, like gold before it, will become a commonly used tool to settle international trade. While each country has strong incentives to shun Bitcoin and push its currency, the former is the only way to guarantee fair trade.
It would only take a couple of larger countries to follow El Salvador’s lead to tip the balance of scales in favour of crypto adoption.
Russia and Bitcoin
Only a few months ago, there was talk of Russia banning Bitcoin from its borders. Instead, Putin and the Russian Central Bank have taken the more measured approach of coming up with a regulatory framework for Bitcoin and cryptocurrencies. From what is known, Russia might treat Bitcoin in the same way as foreign currencies.
This opens up some interesting possibilities:
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Would the Russian Central Bank hold Bitcoin on its balance sheet as a “foreign reserve”?
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Could Bitcoin be used to settle trade with foreign countries?
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Could Russia even dedicate state resources towards mining Bitcoin?
Transitioning to Bitcoin would be a relatively simple task in Russia, given the high levels of adoption within the country. Russia is the 3rd largest contributor to Bitcoin’s hash power. Furthermore, 7.3 million people, 11.9% of Russia’s total population, reportedly own cryptocurrency.
Russia is becoming increasingly important in the geopolitical landscape. It has strong ties to Europe, which it supplies with natural gas, and is also intimate with China since its position is key to developing the Belt and Road infrastructure.
In any case, Russia opting to regulate Bitcoin does two things. First, it legitimizes cryptocurrencies. But, most importantly, it puts pressure on other nations to do the same.
Bitcoin, CBDC and Game Theory
As I have explained before, Bitcoin shares many similarities with gold, which makes it an ideal asset for countries to settle trade-in. Bitcoin is decentralized, not controlled by anyone, secure and trustless. The experiment of using USD to settle trade around the world has left many countries feeling cheated. First off, we have unintended consequences like the sovereign-debt crisis created by exchange rate fluctuation. This happened both in Latin America and south-east Asia. The biggest challenge, though, is that all countries are forced to hold USD and T-bills, even if they don’t want to. It creates an imbalance of power that can’t be sustained in the long term both for practical and political reasons.
But what’s the alternative? Russia would love it if everyone used the Ruble, but that’s never going to happen. The Yuan stands a good chance of competing with the USD, but countries are wary of this since they understand how much power it would give China.
No, the only real solution is to use something which can’t be manipulated. What gold did for global trade and finance in the 1800s, Bitcoin will do this century. It is a matter of practicality, and also the result of countries finding an equilibrium.
When it comes to Bitcoin, early adopters will be rewarded, while late adopters will lose out. There are network effects at play that make it so that with every new participant, others have strong incentives to “cooperate” and enter the system.
From a game theory perspective, the incentives would lead to an equilibrium where every country ends up accepting Bitcoin, and those who do so first gain an advantage.
Again, this is the only monetary arrangement that can create a win-win situation. Any other form will be inefficient or lead to geopolitical imbalances. I know that Bitcoin adoption at such a scale seems impossible now, but how likely did it seem 2 years ago that we would have an actual country, El Salvador, using Bitcoin as legal tender.
We also have to understand that Bitcoin and crypto won’t of course replace financial systems and fiat currencies altogether. Instead, they will be the foundation upon which we will build a hybrid system of sorts, at least on the state level. This will involve increased use of stablecoins and Central Bank Digital Currencies.
We can think of Bitcoin as the new gold, stablecoins as the new fiat currencies, and CBDC as the new monetary policy tool for Central Banks.
How does this affect investors?
The possibility that a country like Russia would begin to hold Bitcoin, or even mine it, would be a huge boon for Bitcoin’s price. The latest run-up in the Bitcoin price has often been attributed to strong institutional demand. Well, there is no institution larger and more powerful than Central Banks around the world. The adage, “don’t fight the Fed”, might be applicable here too. Don’t fight Russia.
Those invested in crypto should always keep a significant part of their portfolio defined in Bitcoin. There’s a big difference between Bitcoin and most other cryptocurrencies, especially when we look at network size, decentralization and security. In the last few years, a lot of crypto projects have sacrificed some of these attributes to gain more efficiency.
Ultimately, it will be Bitcoin’s unparalleled security, limited supply, and decentralization (no one controls it and everyone can participate in it) that will make it a real contender as an asset for international trade.
Takeaway
It is becoming increasingly clear that Bitcoin will be globally accepted. The benefits are just too big to ignore, and they are, in my opinion, the only realistic way for countries like Russia and China to disrupt the dollar hegemony
Does that mean that crypto enthusiasts will live out their dreams of a world with no fiat currencies and decentralized finance? Not quite.
Countries will accept Bitcoin because they have no choice, but they will still try to keep as much of a hold as possible on money, especially domestically. However, Bitcoin will remain a great store of value, held by banking institutions, and foresighted investors alike.
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