De-Dollarization in the Age of Blockchain and Digital Currencies

Calls for de-dollarization have been made for decades. As early as 1965, French finance minister Valéry Giscard d’Estaing denounced the “exorbitant privilege” of the dollar which allows the US to indulge in expensive foreign wars. The 2007-08 global financial crisis put the dollar’s supremacy and American monetary and fiscal discipline increasingly into question. De-dollarization has again become a trending topic following the Russia-Ukraine war and the weaponization of the greenback against Russia.

In an attempt to achieve financial and geopolitical autonomy, countries and coalitions of nations including China, Russia, the BRICS (Brazil, Russia, India, China and South Africa), and the European Union have been developing alternatives to the dollar-based payment system and financial infrastructure. In recent years, technological developments, in particular blockchain and digital currencies, have promised new ways to achieve these policy objectives and give new impetus to the de-dollarization agenda.

Blockchain and digital currencies offer key attributes such as neutrality, efficiency, and programmability capable of supporting novel financial applications outside of the traditional financial system. In the framework outlined by Tufts University scholars Zongyuan Zoe Liu and Mihaela Papa in their 2022 book Can BRICS De-dollarize the Global Financial System, these technologies are among the “go-it-alone” strategies (in contrast to “reform-the-status-quo” approaches) that can create entirely new non-dollar-based infrastructure, institutions and market mechanisms to challenge the dollar’s hegemony. 

Notwithstanding the recent crisis in the cryptocurrency sector, the emerging international consensus is to put in place appropriate regulations to harness the potential of these new technologies while providing necessary guardrails. Arguably, challenger nations have all the more incentive to do so, given that radical innovation could permit their financial systems to leapfrog that of the US.

Leverage power

The financial system revolves around actors with the greatest leverage power. The US enjoys an “exorbitant privilege” as the issuer of the global reserve currency, with the US dollar accounting for 60 percent of global reserve portfolios. The unprecedented seizure of some US$300 billion in Russian central bank assets by the US and its allies, however, calls into question the status of fiat reserve currencies as “safe-haven” assets.

In this context, nations seeking a neutral reserve asset will find appeal in decentralized cryptocurrencies such as Bitcoin. Econometric analysis by Harvard University researcher Matthew Ferranti found that a modest risk of sanctions faced by central banks significantly increases optimal gold and Bitcoin allocations. To date, small nations such as Bhutan and El Salvador have started adding Bitcoin to their reserves. If this trend takes hold, it can lead to a redistribution of leverage power away from the largest states and their ability to expand their balance sheets at will.

On the other hand, the tokenization of assets enabled by blockchain technology has the potential to increase the borrowing power of smaller nations and businesses, making them less reliant on US-dominated capital markets. Global bank Citi has estimated that up to US$4 trillion of real-world assets could be tokenized by 2030. Blockchain technology can create niche capital markets characterized by disintermediation, efficiency, inclusive access, and improved liquidity. Perhaps the best known example is El Salvador’s anticipated issuance of tokenized “volcano bonds” to fund Bitcoin mining infrastructure and a “Bitcoin City”. Another possibility is the use of blockchain-based security tokens to unlock global pools of capital for green financing in developing countries.

Infrastructural power

Actors in the global financial system who provide infrastructure for financial activities such as payment and trading wield significant power. They can exercise influence over global norms and rules and the imposition of sanctions. This has been powerfully illustrated by the exclusion of Russia and Iran from the SWIFT bank-messaging system. By leveraging blockchain and digital currencies, nations that attempt to establish alternatives to US-controlled financial infrastructure can offer significant advantages in terms of costs, efficiency, ease of use, and applications. This allows their currencies to scale up faster and achieve network effects.

The prospect of this happening is particularly strong in international trade and settlement. The rise of central bank digital currencies (CBDCs) will make cross-border payments vastly more efficient. As the world’s most advanced CBDC initiative, China’s digital yuan could accelerate an increase in the share of trade denominated in yuan. The digital yuan is expected to interact efficiently with the digitalization of the trade process driven in part by China’s Blockchain-based Service Network (BSN). It can also interoperate with other CBDCs as they emerge through the Project mBridge of the Bank for International Settlements (BIS). In time, its geographic reach could expand, especially across the Belt and Road Initiative (BRI) network and to other key trading partners of China.

More broadly, major jurisdictions around the world are vying to be cryptocurrency hubs hosting next-generation financial infrastructure for digital assets. Hong Kong’s Web 3.0 policy pivot, announced in October 2022, aims to develop a vibrant ecosystem for virtual assets including exchanges, exchange-traded funds, tokenized assets and stablecoin. In April 2023, the European Parliament passed the Markets in Cryptoassets (MiCA) Regulation, positioning Europe as an attractive region for cryptoasset service providers. And despite the market disruptions last year, Singapore still wants to become a responsible digital asset hub, experimenting with programmable money and tokenizing financial assets. By contrast, US regulators have taken a hostile attitude to drive cryptocurrency businesses out of the financial system, with industry players dubbing the approach “Operation Choke Point 2.0”. This risks the US losing key cryptocurrency financial infrastructure and innovation advantages, with the US dollar not being the denomination of choice for digital assets.

Enforcement power

In the dollar system, existing enforcement power is concentrated in the legal systems of Western financial centers and international institutions such as the International Monetary Fund (IMF). We are, however, in the age of lex cryptographica or code-as-law, as blockchain scholars Primavera De Filippi and Aaron Wright have proclaimed. 

Through the use of programmable smart contracts, values, norms and conditionalities can be hard coded into blockchain-based financial infrastructure. This bestows nations that build them with enormous enforcement power and innovative governance mechanisms, reducing the influence of existing US institutions.

One example is again the digital yuan, which provides China with enhanced enforcement of capital controls and an innovative means of opening its economy and financial markets at the same time. The digital yuan enables the Chinese central bank, the People’s Bank of China (PBoC), to monitor real-time capital flows and refactor the digital yuan code to halt excessive capital outflows. Cross-border digital yuan payments will reduce friction and further globalize the yuan while allowing greater supervisory oversight of cross-border flows.

Blockchain technology can also foster trust among de-dollarizing nations by guaranteeing an equitable sharing of enforcement power. As they jointly establish new financial institutions and mechanisms such as the New Development Bank (previously the BRICS Development Bank) and a BRICS payment system, “designed vulnerabilities” or mutual dependencies can be built into blockchain’s modularized and decentralized governance. This could be done by splitting the core functions and decision-making and arbitration power within the system across multiple countries to ensure that no one can dominate. Enhanced trust will increase the adoption of this new financial infrastructure.

Across the full spectrum of power in global finance, blockchain and digital currencies can help rising powers to de-dollarize the global financial system and mitigate the risk of dollar hegemony. At the same time, they have the potential to usher in a fair, efficient, and inclusive financial system. As technology accelerates the move towards a more balanced and multipolar monetary order, it is important that countries collaborate with each other to ensure a new and better financial architecture that is globally integrated rather than geo-economically fragmented.