Bloomberg Special Report | What Changes Does Turmoil Bring to the Monetary System? Cryptocurrencies and the US Dollar are Partners, Not Enemies!

Renowned historian Niall Ferguson recently published an article on Bloomberg titled "Crypto and the Dollar Are Partners, Not Rivals." Niall Ferguson is a senior fellow at the Hoover Institution, Stanford University, and has previously held positions as a history professor at Harvard University, New York University, and Oxford University. He is also the founder of the New York-based advisory firm Greenmantle. Some of his notable works include "The Ascent of Money" and "Colossus: The Rise and Fall of the American Empire."

Below are the key points from the translated and compiled article. For any doubts, please refer to the original text.

Turbulence Will Drive Changes in the Monetary System

"I hope it can create world peace, or help achieve world peace." Niall Ferguson begins his article with a tweet from former Twitter CEO Jack Dorsey about Bitcoin, proposing the argument that war will bring greater demand for Bitcoin.

Using examples such as the Hundred Years' War between England and France and the Black Death, where salt prices rose sevenfold from 1347 to 1352, Ferguson illustrates how survivors of the Black Death were able to exchange labor for wages, leading to the monetization of the English economy. During the Spanish conquest of the New World, the increased supply of silver and gold altered the global economy. Following World War II, with Britain heavily in debt, the international monetary system, previously dominated by the pound, gradually shifted to the dollar. During the Vietnam War, the link between gold and the dollar was severed, ushering in the era of floating exchange rates.

From these examples, Ferguson believes that the transformation of monetary systems is often associated with periods of turbulence.

Two Assumptions about the Future Financial Order

Over the past two years, two significant events that have impacted the international financial order are the Covid-19 pandemic and Russia's invasion of Ukraine. Ferguson believes that two assumptions have emerged.

Firstly, the era of cryptocurrencies has arrived, and the weakening of the dollar is imminent. According to Zoltan Pozsar, a currency market expert at Credit Suisse, in his report released on 3/7, as the world reduces its reliance on the dollar and dollar-denominated bonds, Bretton Woods III will lead us back to external currencies like gold and other commodities.

BitMEX founder Arthur Hayes, in his article "Energy Cancelled" on 3/16, also agrees with Zoltan's views. He believes that Western countries' severe actions in confiscating various G10 currencies held by Russia for sanctioning Ukraine and expelling Russia from the SWIFT system are excessive. When a country's reserves can be unilaterally confiscated by operators of digital fiat currency networks, no central bank should use Western currencies as their foreign exchange reserves.

While many scholars have expressed similar views, Ferguson responds with a quote from former US Treasury Secretary Larry Summers: "When Europe is a museum, Japan is a nursing home, China is a prison, and Bitcoin is an experiment, what currency is more suitable than the dollar for reserves and trade?"

Are Cryptocurrencies Really That Important?

Reflecting on the atmosphere in the crypto market at the beginning of the Russia-Ukraine conflict, there was a surge in ruble purchases of Bitcoin, with discussions worldwide on whether cryptocurrencies could help Russia evade international sanctions.

However, with regulatory authorities in Europe and the US issuing orders, addresses associated with illicit activities have been significantly blocked. Tigran Gambaryan, Deputy Head of Intelligence and Investigations at Binance, also stated, "For governments and countries, cryptocurrencies are not a very effective way to evade sanctions."

According to a report by the Financial Times, around $1.06 billion in cryptocurrencies flowed into Ukraine, with Ethereum founder Vitalik Buterin and Polkadot founder Gavin Wood expressing their support on Twitter. However, when compared to the military aid Ukraine receives from the US government, $1.06 billion is just a small fraction.

Note: If the latest proposal by the Biden administration receives congressional approval, the total aid amount could reach $196.7 billion.

In essence, Ferguson believes that cryptocurrencies like Bitcoin and Ethereum are attractive assets in unstable regions and periods. However, certain stablecoins may be more attractive as they are pegged to the dollar. This is why stablecoin trading volumes were high in Turkey in 2020 and 2021, as the Covid-19 pandemic and Turkey's reckless monetary policies led to the devaluation of the lira.

The Failure of the Dollar Theory is Exaggerated!

Ferguson states that starting from the onset of the pandemic in 2020, the performance of Bitcoin and Ethereum has been better than gold. Even during recent times of war, Bitcoin and Ethereum have each risen by 3.8% and 9.1%, while gold has fallen by 1%. "During wartime, what people need are assets that can preserve or acquire value." Although Ethereum's transaction processing efficiency of 15 transactions per second is significantly lower than VISA's thousands of transactions per second, for Russia during wartime, "being able to buy Bitcoin" is more important than "whether Western payment companies can block Russian payments," as Russia has been developing its own payment system NSPK and domestic card system Mir since 2014.

Ferguson expresses concerns about China's payment system potentially dominating the world a few years ago, but notes that China's ambitions have been curtailed due to the government's restrictions on the international expansion of private enterprises:

• In the vast arena of the global economy, digital payments are more critical than cryptocurrencies. Payment systems like Alipay and WeChat Pay, which utilize artificial intelligence and can integrate and analyze data for credit ratings, are much faster than blockchain. Fortunately for the West, the Chinese government has hindered the international expansion of these private enterprises.
• TikTok's parent company, ByteDance, is activating payment functions.
• Telecom operators in emerging countries like Africa and South Asia use Huawei's Mobile Money solution. China also owns O-Pay, Africa's second-largest mobile payment platform.
• The China-supported national blockchain network BSN.
• The digital yuan, DCEP.

However, Ferguson believes that if China wants to establish a payment system outside the dollar, it still has a long way to go, as it holds a significant amount of dollar reserves. Under the backdrop of the Russia-Ukraine war, the US freezing Russian assets has surprised Beijing. Ferguson believes that this has proven the predictions of the dollar's decline wrong since the 1960s.

While the percentage of the dollar in international reserves has decreased, central banks have not shifted to holding renminbi. Instead, they have turned to Canadian, Australian, Swedish, Korean, and Singaporean currencies. This has not diminished the dollar's dominant position and financial sanction capabilities, as even Switzerland is willing to cooperate with sanctions.

Moreover, the most commonly used currency for international payments is still Western currencies:

He cites Sebastian Mallaby, a researcher at the Council on Foreign Relations:

The failure theory of the dollar is greatly exaggerated. Three-fifths of foreign private currency bank deposits worldwide are in dollars, and foreign currency loans by companies are also at a similar proportion. The Federal Reserve estimates that foreigners hold about half of the US dollars in circulation. Foreign central banks also hold many dollars because they know many people are willing to accept them.

These reasons explain the extraordinary rebound of the dollar this year, with the dollar significantly strengthening against most major currencies, especially the yen, which has depreciated by nearly 27% since early 2021, the euro down 16%, and the pound down 10%.

Regulation Is Essential for the Crypto Industry

Aside from viewing cryptocurrencies as an experiment like Larry Summers, many consider them to be Ponzi schemes.

Ferguson believes that many people currently favor UST like Lehman Brothers, which can only operate smoothly when there is no bank run. He also quotes SBF, founder of FTX, on the concept of Yield Farming, where liquidity providers' assets are used by project teams in higher-yield mining pools, with the project teams only needing to provide so-called "governance tokens" as rewards.

Additionally, DeFi suffered losses of around $10 billion in 2021 due to hackings. Because of these seemingly unstable factors, the crypto industry urgently needs regulation.

The Dollar and Cryptocurrencies Will Complement Each Other

According to a survey by intelligence company Morning Consult, 20% of US adults and 36% of millennials hold cryptocurrencies. Cryptocurrencies are ubiquitous in today's America, with the mayors of Miami and New York City touting their support for Bitcoin, Colorado and Florida vying to be the top states for cryptocurrencies, two NBA arenas being named after crypto companies, and PepsiCo and Applebee's launching their own NFTs.

Most importantly, crypto companies are donating millions to candidates and other businesses, and lobbying firms have launched national campaigns to win support for cryptocurrencies.

Ferguson believes that the US achieved great success in the Web 1.0 and Web 2.0 eras due to relatively lax legislation, particularly the 1996 Communications Decency Act and its Section 230.

Essentially, Section 230 created a special regulatory space for internet platforms, exempting them from legal liabilities associated with publishing companies while granting them the right to moderate content as they see fit.

Looking back, what would Section 230 for DeFi or Web3 look like? In the latest article by financial historian Manny Rincon Cruz, he presents three perspectives:

1. Developers of decentralized protocols do not need to identify themselves as Virtual Asset Service Providers (VASPs):
   Code is protected by free speech, and decentralized protocols do not require intermediaries when providing exchange, custody, or transfer services, as transactions occur directly between DeFi users.
2. Excluding DeFi "loopholes" from the Computer Fraud and Abuse Act, CFAA:
   Loopholes refer to users writing code to interact with protocols and exploiting arbitrage opportunities or vulnerabilities to profit. As long as users do not violate other criminal laws, when users use loopholes to expose faulty code, it will help DeFi grow.
3. No need to impose banking charter requirements on stablecoin issuers like Circle and Tether:
   Unlike bank deposits, users can sell their USDC or USDT without redemption. Since these stablecoins do not lead to "bank runs," they should not be subject to specific banking regulations.

Regardless, the current debate on initial Web3 regulation has just begun. The dominance of the dollar and the thriving crypto industry will not replace each other but will complement each other.

"Just as Bitcoin never intended to be, and never will be, a substitute for the dollar, DeFi is a supplement to the existing financial system rather than a substitute. Undoubtedly, we will continue to use it in the coming decades to pay our taxes, even for paying our employees' salaries and utility bills," Ferguson concluded.