The Future of Capital Controls (November 2022)

Crypto is flush with innovation. At the same time Government has proven to be wasteful and slow moving. Yet, the government maintains full capital control. What does this mean for the future of crypto?

On one hand, a large percentage in Crypto enthusiasts believe the innovation and efficiencies of crypto can improve Government’s functioning. The Government though is afraid to quickly venture into those waters, for the same reason employees are afraid of Robotics. History has shown though, that change is generally good and not destructive in any permanent way.

Let’s explore a few ideas about how capital controls might impact crypto, defi and government controls on capital.

Central Bank Digital Currencies

A CBDC is an alternative form of fiat currency as an electronic record or digital token of a country’s official currency. CBDCs use much of the same underlying technology as cryptocurrencies, but rather than de-centralizing control of money and enabling secrecy, they centralize the infrastructure of a digital currency, enabling greater control and inspection.

As such, A CBDC is issued and regulated by the state’s monetary authority or central bank. CBDCs are backed by the full faith and credit of the issuing government. Ninety countries (representing more than 90% of global GDP) are exploring a CBDC, while nine countries have fully launched such a currency. However, all of those countries that have launched a CBDC are small with limited currency float.

If, or probably when, the U.S. introduces the Digital Dollar (or whatever they call it), it will become an instant hit as around 60% of all global commerce is in dollars. But, what next?

Other nations suffer when the dollar is too strong. They also suffer when it is too weak and American consumption dries up. Possibly, less reliance on the dollar, without a collapse is the right medicine. We’ll see, because a more diversified global currency seems in the cards and Bitcoin appears to be at the forefront of diversifying central bank reserves, especially in emerging markets.

The U.S. Dollar as the World’s Dominant Reserve Currency” was recently discussed by the Congressional Research service. I encourage you to read it.

The innovator’s dilemma or the Government’s dilemma?

The decision whether or not to launch a U.S. CBDC and build the infrastructure it requires bears all the hallmarks of the “innovator’s dilemma”—the business scholar Clayton Christensen’s framework for understanding the difficult choices facing incumbents responding to disruptive technologies.

Applying Christensen’s framework to Washington’s decision to launch a CBDC, the innovator’s dilemma facing U.S. policymakers can be described like this:

  • A dominant incumbent (the U.S. dollar) garners the lion’s share of industry profits and benefits, but only incrementally innovates (e.g. SWIFT.gpi and FEDNow infrastructure upgrades) to meet customer needs.
  • Meanwhile, insurgent innovators (e.g. digital currencies, stablecoins, decentralized payment networks) enter the market using new technologies (e.g. blockchain) and experience rapid adoption due to a superior value proposition (e.g. faster transactions, lower costs, privacy, flexibility, “bank by device”), but face a “chasm” before mass scale adoption.
  • Larger industry players (e.g. central banks, China) adopt the same technologies both to protect their own business from these disruptors but also to gain market share from the dominant incumbent.
  • Adoption by these large industry players and entrepreneurial fervor by the insurgents increases the disruption’s value to customers, making eventual mass scale adoption inevitable.
  • The dominant incumbent now faces a hard choice: whether to adopt or fight against these disruptive technologies—and if adopting, how to do so effectively.

SWIFT and the U.S. dollar have competitions coming from two directions: 3000+ cryptocurrencies and 90+ central bank digital currencies. (Brookings) Now, SWIFT was Established in 1930, the BIS is owned by 63 central banks, representing countries from around the world that together account for about 95% of world GDP. So, its a private settlement company so to speak with a central banks board.

Now the CBDC effort to us SWIFT is kind of self fulfilling prophesy because either they use SWFT or the United States new CBDC becomes a competitor of SWIFT. It appears that US CBDC is on track as the Federal Reserve Bank of New York has revealed the successful completion of a test that involved the use of a central bank digital currency (CBDC) for wholesale, cross-border transactions, exchanging a U.S. digital dollar with experimental foreign currencies on separate blockchains on Nov. 4th 2022.

Now that test also appear to be a Direct CBDC payment system that went directly into currency markets. So clearly there is some internal interest in using a Direct form of a CBDC. So, I’ll be highly surprised if the the Fed just gives up that new found capital control globally without a fight or some regulation to restricts them.

So what do we end up with?

The United States Government has the opportunity to really expand its reach globally in a very positive way, in the midst of a crisis, and the accompanying financial carnage. Yet avoiding some type of dystopian CBDC is more complex considering we don’t really even know what CBDC will communicate in the future outside of it may or may not be like a digital wallet.

On another note, I think barring a rogue CBDC or agencies like Gensler’s SEC who uses the date to target user I’d think a dystopian type CBDC is less likely while I believe Capital Controls are guaranteed. The question really is how will United States gain access of information. I think the bigger question is, how long does’ a CBDC have full Capital Controls until congress limits that. I think other countries who use United States CBDC will fall under similar restriction to SWIFT and maybe IMF rules in some way. At some point they will develop a digital treaty to encourage participation.

In any case I think the most likely outcome is a Hybrid CBDC that can deliver to Central Banks, Regional Banks, and Retail (US) with or without a third party. I think congress gets involved out fear of the other party get to much control so we end up with some laws to work through over the coming years. Currently, it’s no man’s land! I have to admit I don’t like that feeling…just going to make sure I don’t piss anyone off.

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Scott Henderson’s Risk Disclosure & Disclaimers

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