Jay Newman was a senior portfolio manager at Elliott Management and is the author of Undermoney. Richard Carty was managing director of Morgan Stanley Principal Strategies and CEO of Bonanza Creek Energy.
It’s no surprise that the US Treasury — whose remit includes combating threats to the dollar and protecting the integrity of the financial system — is warning Congress that dollar-based digital instruments, stablecoins, and crypto exchanges pose significant risks.
But risks to whom?
Crypto “dollars” won’t collapse the world financial system, but they could disrupt the cosy greenback-based settlement system. Pre-eminence of the dollar as the currency of choice for contractual settlements, coupled with the depth and sophistication of US capital markets, has enabled the US and other Western governments to police bad actors by imposing economic sanctions on people they don’t much like.
Unfortunately for the US and its allies, as events currently unfolding in Hong Kong accelerate, CCP-controlled crypto stablecoins and related exchange transfer platforms will eviscerate this prerogative.
The French have long complained about exorbitant privilege — the ability of the US to finance fiscal policies by printing dollars. For the past fifteen years, the BRICS have taken this to heart, seeking an alternative to avoid Uncle Sam’s heavy hand and freedom to snoop on all their financial dealings.
But the BRICS don’t need to invent a new currency or transfer system. The best “new” money is here: digital dollar stablecoins and other tokenised crypto pseudocurrencies. Unlike the “old” dollar — easily regulated, tracked, and tethered to Washington DC — offshore crypto transfer systems operate outside the extant global regulatory net. They’re effectively stateless.
Dollar-cryptos are, of course, not currencies at all, they are simply components of an alternative money transfer system, akin to Western Union, Fedwire, or SWIFT, but without disclosure or regulation. They are risky “assets” because there is no underlying collateral: essentially, they’re unsecured obligations of the issuer of the token. For the most part, offshore crypto exchanges require no regulatory collateral.
What if those risks were ameliorated?
Large-scale acceptance of crypto tokens can provide a robust settlement mechanism for legitimate economic activities. But they really shine as tools for illegitimate activities, letting all manner of criminals conduct business in dollars while bypassing the oversight mechanisms of the Federal Reserve, the CFTC, the SEC, the IRS, and banks subject to American regulation
One collateral consequence of broad-based acceptance of offshore crypto tokens would be the evisceration of the Trading with the Enemy Act of 1917 and the 1977 International Emergency Economic Powers Act. These provide the foundation for US government sanctions against countries and individuals “to deal with any usual and extraordinary threat, which has its source in whole or substantial part outside the United States.” Those statutes create a national security/emergency hook for actions that are, primarily, driven by foreign policy, criminal enforcement, and economic objectives.
Consider this: had Russia held crypto tokens on a hard drive instead of holding reserve assets at G7 central banks, $600bn of reserves that were blocked by Western sanctions would have been frustrated. Ditto the accounts of hundreds of Russian oligarchs, and those of another 12,000-odd individuals and companies currently under American sanction.
Binance this week pleaded guilty to criminal charges related to money laundering and breaching international financial sanctions, having failed to report suspicious transactions with organisations the US described as terrorist groups including Hamas and al Qaeda. Reuters reported in June that “hackers, fraudsters and drug traffickers”, including groups under US sanctions for assisting North Korea’s nuclear weapons program, have moved at least $2.3bn through the exchange over the past five years.
Threats to the current order are being rendered operational by the Hong Kong-based crypto companies and exchanges with direct ties to the Chinese Communist party (CCP). Everything in Hong Kong requires CCP approval: it’s well documented that the CPP seeks to dethrone the US dollar and the dollar clearing and settlement systems. Not least because of bitter CCP complaints over US sanction policies. It’s natural that the CCP would drive the institutionalisation of Hong Kong as a centre for digital assets — even to the point of “suggesting” Western banks, like HSBC and Standard Chartered accept Hong Kong-based crypto exchanges as clients, thereby creating a critical conduit link to the traditional banking system for the crypto exchanges.
Implicit control over a system of crypto token exchanges, clearing systems, and custody mechanisms, would offer the CCP a lot of information and bang for the buck. Infusions of Chinese government resources could expand the capitalisation of Hong Kong crypto exchanges, making it a centre for crypto tokens.
There are obstacles.
Scale is one. The current value of Hong Kong USD tokens is paltry: $4bn — but up from nothing in late 2021. A pittance in terms of capital markets, this could grow fast if even a modest portion of the one trillion of greenbacks in circulation worldwide — and a slice of China’s $800bn hoard of US Treasuries — shift.
The space is ripe for a CCP takeover. Roughly $123bn in dollar stablecoin tokens are in circulation elsewhere. Tether alone accounts for some $83bn in capitalisation. Tether is owned by iFinex, a Hong Kong company that already has a long relationship with China. The FT and the Wall Street Journal cover Tether extensively, including its opaque ownership, dubious accounting for purported 1-for-1 US dollar reserves, and popularity in illicit finance. A top ISIS figure allegedly uses Tether as his piggy bank. More recently, Tether, facilitated by the Tron stablecoin transfer network (where 93 per cent of all transactions involve Tether), seemingly unwittingly, failed to catch that its stablecoin was funding terrorist groups in the Palestinian territories.
Hong Kong hosts newer entrants: it’s CCP’s digital asset testing ground. TrueUSD ramped to $3.3bn in circulation since late 2021; it’s controlled by Techteryx, which is connected to the crypto exchange Binance, which originated in China and, despite denials, is reported to retain ties.
The latest entrant, August 2023, is First Digital USD ($467mn in circulation) controlled by a newly formed Hong Kong trust. The beneficial owners of Techteryx and First Digital aren’t disclosed. A respected crypto analyst, Adam Cochran, has linked both entities with a crypto tycoon named Sun Yuchen, better known as Justin Sun. Sun denies any connection,
Sun is also the inventor of an “algorithmic” crypto dollar coin, USDD ($72mn in circulation). In March of 2023, the Securities and Exchange Commission lodged a civil fraud complaint against him. By one account, he’s also the subject of a US Department of Justice Department criminal investigation. An investigation of Tron, another of Sun’s crypto token transfer platforms, by blockchain analytics firm Chain Argos suggests transactions linked to Hamas, Hizbollah and other terror groups “in the billion-dollar range.”
For further reference: in 2021, Sun joined a research project with the China Academy of Information and Communications Technology. Citing a government statement, CoinDesk reports the project was approved by the Central Party Committee to consider using blockchain in social governance. The project’s team “includes members from the People’s Bank of China, Central Cyberspace Administration — China’s internet watchdog — as well as scholars from CAICT, the China Information Association, Tsinghua University, and Peking University.”
For the US and Western institutions more generally, there’s enormous risk in the possibility that the CCP will be successful in establishing Hong Kong as a hub for global trading and clearing of crypto. Hong Kong-based digital instruments and exchanges will be opaque to the outside world with disclosure exclusively provided to Chinese authorities: all others will find them impossible to monitor — much less tax or control via domestic sanctions actions. Western notions of a rule of law, and the institutional scaffolding of modern capitalism — imperfect as they might be — will be absent.
What’s more, the Chinese government issues its own Central Bank Digital Currency (CBDC), a digital yuan, giving it better visibility and granular control over those funds. According to the Human Rights Foundation, implications for human rights are significant: paper cash can transact outside of the oversight of a totalitarian regime, CBDCs are tools of surveillance and social engineering.” Tron is now issuing its own yuan-denominated currency, which is likely to be convertible with the official yuan.
It’s not just that dollar-based stablecoins and the related crypto exchange and transfer platforms controlled, effectively, by the CCP would create a headache for Western law enforcement. Economic policymakers may find that, in the longer term, dollar-based stablecoins and extraterritorial exchanges and transfer systems could be used to dilute the dominance of the dollar in global trade and finance, consequently increasing the cost of funding the vast existing US debt stock as well as ongoing fiscal and balance of payments deficits incurred by the US.
The ability to export American values and achieve economic objectives has long been eased by demand for the dollar: its strength, its (relative) stability, multilateral acceptance, the soundness of American regulatory institutions, and the ability to police dollar-denominated transactions.
It’s all well and good for the US Treasury to warn of a coming storm, but, given the chaotic domestic political environment, it’s difficult to imagine Congress engaging productively without a non-partisan understanding of the urgent need to protect the primacy of the US as the centre of the global settlement system.
There are no perfect antidotes. One solution could be for the US government to create its own crypto exchange or to issue its own crypto token, but the Fed or in Congress are dragging their feet. Ignoring a problem won’t make it go away. Perhaps Congress needs to focus, as well, on expanding the Racketeer Influenced and Corrupt Organizations Act (RICO) and the Foreign Sovereign Immunities Act (FSIA) to provide more tools for securing injunctive relief, damages, and enforcement against creators, facilitators, and users of non-compliant pseudo-dollars and transfer platform conduits.
The emergence of an opaque, unregulated offshore dollar-denominated transfer mechanism is directly counter to US interests. It’s up to the US to offer an alternative or to define what constitutes acceptable compliance.
It doesn’t look like much today, but the Hong Kong-based crypto dollar and dollar-based offshore transfer systems are like US national debt: don’t matter until they do. As Hemingway might have put it, crypto adoption and facilitation driven by the CCP may well happen gradually, but, suddenly, it could become a new standard.
By then, the “old” dollar and incumbent global settlement system will have escaped US control for good.
