Digital currency is getting serious

North Korea is, apparently, developing a digital currency of its own. According to Alejandro Cao de Benós, President of the Korean Friendship Association, the Democratic People’s Republic of Korea intends to go down the Facebook route by creating an asset-backed digital currency rather than a digital fiat currency and then use some sort of blockchain with “Ethereum-style smart contracts” to do business and avoid sanctions.

Why use a blockchain? Well, the regime sees such “smart” “contracts” as a way to enforce deals it makes with foreign counterparties. Since it doesn’t trust the U.N., it relies on Chinese intermediaries to enforce deals abroad. But sometimes, so sources claim, those intermediaries cheat the North Koreans. Hence, they want to bypass intermediaries altogether by developing a  “token based on something with physical value” (eg, gold) in order to create a stable mechanism for payments in international trade between the regime and “other companies/individuals” (although it will not be available to individuals in the DPRK, who will be stuck with the Korean Won).

(This is not a new idea, by the way. A couple of years ago, the Venezuelans tried a similar idea “the petro”, a digital currency to be backed by the country’s natural resources — diamonds, gas, gold and oil — to beat the “financial blockade” imposed by the U.S. and others. I will check the world currency markets later on, but my general sense of the matter is that the petro is yet to topple the Swiss Franc. It, may, however have served as a useful input to other regime’s feasibility studies.)

This is why U.S. (and other countries) care whether the North Koreans launch an eWon that stops them from being cheated in international transactions. As the Financial Times points out, the U.S. has a genuine and well-founded concern that, the financial implications of a change to U.S. currency hegemony to one side, foreign countries will increasingly use digital currencies, “such as Facebook’s planned Libra coin“, to avoid sanctions. Indeed, this was one of the arguments that David Marcus uses. He says, for example, that a Chinese digital currency running on a Chinese permissioned blockchain could mean the potential for “a whole part of the world completely blocked from U.S. sanctions and protected from U.S. sanctions and having a new digital reserve currency”.

Sanctions are a serious thing and cryptocurrency doesn’t have a magic shield against them. An Ethereum developer was recently arrested for violating U.S. sanctions against North Korea. According to the U.S. Department of Justice, one Virgil Griffith was arrested at Los Angeles airport and charged with violating their International Emergency Economic Powers Act (“IEEPA”) by travelling to North Korea to give a presentation about using cryptocurrency to evade sanctions. As observers pointed out, Mr. Griffith may have evolved a sub-optimal communications strategy in connection with his travel plans.

A North Korean digital currency has every chance of succeeding under the stewardship of the Korean Worker’s Party and the divine tutelage of Kim Jong-Un, the Dear Leader. His father, the previous Dear Leader, most famous for being the greatest golfer in history, was responsible for an earlier experiment in radical transformation through money, when the DPRK fell into chaos after his government revalued the currency and restricted the trading in of the old money (thus wiping out the personal savings of counter-revolutionary running-dog lackeys of U.S. imperialism).

When the North Korean people were not eating tree bark to stay alive, they must surely have noticed that the revaluation of the unit of account didn’t make the slightest difference to the supply and demand for goods and services. It made a difference to the market, though. The revaluation and exchange limits triggered panic, particularly among market traders with substantial hoards of old North Korean won — much of which became worthless. Gresham’s Law took immediate effect: the KRW disappeared from the marketplace and people began to use whatever hard currencies they could get their hands on. The Dear Leader therefore launched an attack on this as well, banning everyone (including foreigners) from using foreign currencies such as euros or dollars. The authorities started a TV campaign asking good citizens to report anybody using dollars directly and I imagine that the same will apply to digital dollars or electronic euros.

So, if a North Korean digital currency based on gold or whatever does appear, would it help the regime and others to avoid sanctions? Well, it depends. It is certainly possible to design digital currencies that have unconditional anonymity that Bitcoin (for example) does not. Perhaps this is what Mr. Griffith was explaining to the North Koreans in Pyongyang, although to be honest they could have discovered this for themselves on the Internet without too much trouble. So let’s imagine that they do indeed create such a beast, a bastard child of ZCash and Quorum. What will happen? Well, in a recent “war-game” of this scenario hosted by the Economic Diplomacy Initiative and co-sponsored by the Belfer Center for Science and International Affairs at Harvard (involving U.S. administration veterans, diplomats and academics), the rise of an encrypted digital currency attacked the dollar’s international position and ended up allowing North Korea to bypass sanctions and build an intercontinental ballistic missile. Ruh roh, as they say on the internet.

(The North Koreans have other options for disruption using digital currency, by the way. See John Cooley’s book on counterfeiting Currency Wars, which is about various attempts to destabilise countries by forging their currencies. He talks a lot about North Korea’s “superdollar” forgeries and the like. Now, think what the coming version of this might be: not counterfeiting physical money, but creating electronic money. I can’t help but wonder whether the shift to digital money for retail and person-to-person payments will make a modern-day Operation Bernhard — Hitler’s plan to undermine the British economy by forging £5 notes — easier or harder?)

The Foundation for Defense of Democracies (FDD), a Washington think tank, summarise the situation quite well in their position paper “Crypto Rogues” observing that “blockchain technology may be the innovation that enables U.S. adversaries for the first time to operate entire economies outside the U.S.-led financial system”. Now, while this may be technically slightly inaccurate (there are ways to create anonymous transactions without a blockchain, but let’s take this use of “blockchain” to mean “third-party anonymous digital currency”) it does accurately flag up that the widespread availability of decentralised financial services threatens to bypass the existing infrastructure. The FDD are surely right to say that “blockchain sanctions resistance is a long-term strategy for U.S. adversaries”.

Now, whether using the blockchain to create an immutable record of sanctions-busting transactions is a good idea or not I couldn’t say, but as a general rule I’m someone who believes in the democratic process and therefore I’d prefer it if sanctions could not be so easily evaded. Especially when you consider why the sanctions are there in the first place.

(A recent U.N. report estimates that North Korea has generated some $2 billion for its weapons of mass destruction programs using “widespread and increasingly sophisticated” cyberattacks to steal from banks and cryptocurrency exchanges. It makes you nostalgic for the days when hackers were stealing credit card numbers to access porn.)

No-one would imagine that a digital currency by itself would render sanctions ineffective. When the Iranian regime, for example, set up a venture to explore Bitcoin payments with a Swedish startup, the Swedish banks refused it a bank account because they themselves did not want to become subject to secondary sanctions. As US Treasury Secretary Mnuchin said at the G7 in July (talking about Iran), “If you want to participate in the dollar system you abide by US sanctions”. There is no doubt, though, that moving transactions outside of the international monetary and finance system could help to make other sanctions-evading tactics more effective by making it more difficult to track, trace and monitor transactions.