Summary of the thesis
As bitcoin (BTC-USD) recovers from its recent plunge, the world’s leading cryptocurrency has taken center stage in geopolitical news as speculation over Russia’s relationship with bitcoin ran wild.
The timing couldn’t be more significant as tensions build over Ukraine, raising many interesting questions about dollar hegemony, Bitcoin’s role in international politics, and game theory.
Ultimately, I believe that Bitcoin, like gold before it, will become a commonly used tool for conducting international trade. While every country has strong incentives to shun bitcoin and promote its currency, the former is the only way to guarantee fair trade.
It would only take a few larger countries to follow El Salvador’s example to tip the balance in favor of crypto adoption.
Russia and Bitcoin
Just 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 developing a regulatory framework for Bitcoin and cryptocurrencies. For all that is known, Russia could treat bitcoin the same as foreign currencies.
This opens up some interesting possibilities:
Would the Russian central bank keep bitcoin on its balance sheet as a “foreign reserve”?
Could bitcoin be used to conduct trades with foreign countries?
Could Russia even use state resources to mine Bitcoin?
Transitioning to Bitcoin would be a relatively easy task in Russia given the high level of adoption within the country. Russia is the third largest contributor to Bitcoin hash power. Additionally, 7.3 million people, 11.9% of the total population of Russia, reportedly own cryptocurrencies.
Russia is becoming increasingly important in the geopolitical landscape. It has strong ties to Europe, which supplies it with natural gas, and is also closely linked to China, as its position is key to the development of the Belt and Road infrastructure.
In any case, Russia’s decision 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 explained earlier, Bitcoin shares many similarities with gold, making it an ideal asset for countries to trade in. Bitcoin is decentralized, controlled by nobody, safe and trustworthy. The experiment of using USD to settle trades around the world has made many countries feel cheated. First of all, we have unintended consequences like the sovereign debt crisis caused by exchange rate fluctuations. This happened in both Latin America and Southeast Asia. But the biggest challenge is that all countries are forced to hold USD and T-Bills even if they don’t want to. It creates a power imbalance that is unsustainable for both practical and political reasons.
But what is the alternative? Russia would love for everyone to use the ruble, but that will never happen. The yuan has a good chance of competing with the USD, but countries are cautious, understanding how much power it would bring to China.
No, the only real solution is to use something that cannot be manipulated. Bitcoin will do in this century what gold did for global trade and finance in the 18th century. It is a matter of practicality and also the result of countries finding their balance.
When it comes to Bitcoin, early adopters will be rewarded while late adopters will lose. There are network effects at play, which means that every new participant has different strong incentives to “cooperate” and enter the system.
From a game-theoretical perspective, the incentives would lead to an equilibrium where all countries end up accepting bitcoin and those who do so first get an advantage.
Again, this is the only monetary arrangement that can create a win-win situation. Any other form is inefficient or leads to geopolitical imbalances. I know the adoption of bitcoin on such a scale seems impossible now, but how likely it seemed 2 years ago that we would have an actual country, El Salvador, using bitcoin as legal tender.
We must also understand that Bitcoin and crypto will of course not completely replace financial systems and fiat currencies. Instead, they will form the basis on which we will build some kind of hybrid system, at least at the state level. This will include 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 start holding Bitcoin or even mine it would be a huge boon for Bitcoin’s price. The recent surge in bitcoin price has often been attributed to strong institutional demand. Well, there is no institution bigger and more powerful than central banks around the world. The adage “Don’t fight the Fed” could also apply here. Don’t fight Russia.
Those investing in crypto should always keep a significant portion of their portfolio defined in Bitcoin. There is a big difference between Bitcoin and most other cryptocurrencies, especially when we consider network size, decentralization and security. In recent years, many crypto projects have sacrificed some of these attributes in order to achieve greater efficiency.
Ultimately, it will be Bitcoin’s unparalleled security, limited supply, and decentralization (no one controls it and anyone can participate) that will make it a real contender as an asset for international commerce.
It is becoming increasingly clear that Bitcoin will be accepted globally. The benefits are simply too great to ignore, and they are, in my opinion, the only realistic way for countries like Russia and China to break dollar hegemony
Does this mean that crypto enthusiasts will live out their dreams of a world without fiat currencies and decentralized finance? Not quite.
Countries will accept bitcoin because they have no choice, but they will still try to hold the money as best they can, especially domestically. However, Bitcoin will remain a great store of value held by banking institutions and forward-thinking investors alike.
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