National Digital Currencies Raise New Risks of Grand Corruption

In 2017, you may have heard of this thing called blockchain. The technology, which works by creating a decentralized, encrypted, and independently verifiable ledger of transactions distributed over a network of computer systems, has allowed innovations in the design of secure systems for recording votes, registering land ownership, and confirming digital identity. The most famous application of the blockchain, however, has been the creation of digital currencies such as Bitcoin, Ethereum, and Ripple. Many private individuals consider these currencies to be the way of the future, and the death knell of the central banker: universal, transparent, and valued according to mathematical laws rather than political preferences, cryptocurrencies—according to their proponents—will bring with them immeasurable benefits, among them making the fight against corruption easier by allowing all interested parties to “see the entirety of any transaction instantly and accurately.”

But private citizens aren’t the only ones who have heard of the blockchain: the same central bankers who are meant to be rendered irrelevant by the advent of cryptocurrencies have also taken notice. Several governments, including those of Israel, Russia, China, Estonia, Sweden, and Venezuela, have announced plans to create their own national digital currencies (NDCs) based on blockchain technology. While there are several sound economic reasons for introducing an NDC, governments frequently cite the same anticorruption benefits mentioned above.

However, there are crucial differences between NDCs and cryptocurrencies like Bitcoin. Rather than open architectures enabling full financial transparency, most NDCs currently plan to use some form of centralized ledger, giving government authorities (and only them) the ability to see and police transactions. While such centralized transparency will give honest governments a much-needed boost in the fight against corruption, it will also give oppressive and kleptocratic regimes another tool with which to steal from and oppress their populations.

To understand why, it is worth emphasizing some crucial technical differences between various cryptocurrency designs. While Bitcoin, the most well-known cryptocurrency, works on a distributed ledger, cryptocurrencies don’t have to be fully decentralized; they can feature either distributed or centralized ledgers. Distributed ledgers are built on a proof-of-work model: Bitcoin “miners”—individuals who have downloaded special software—devote computing power to the verification of transactions. Verified transactions are recorded as blocks. Each new block issued contains both a new, verified transaction as well as a record of all previous transactions. Anyone (even a Russian nuclear scientist) with enough spare computing power can be a miner, and anyone can review the most recent Bitcoin blocks posted. While great for transparency, distributed ledgers are extremely resource-intensive; since verifying each new transaction requires solving computationally-intensive math problems, miners must devote enormous computing power to creating new blocks.

By contrast, centralized or semi-centralized ledgers do not use the proof-of-work model employed by Bitcoin. Instead, they rely on a trusted validator (or a network of several) to examine transactions and reach consensus on their validity. Such ledgers are more lightweight, and can process transactions much more rapidly than Bitcoin. The cryptocurrency Ripple, for instance, relies on a relatively small network of validators (chosen by Ripple) to verify transactions. While Ripple has chosen reputable validators from diverse institutions to prevent collusion, a less scrupulous blockchain host using Ripple’s technology need not do the same. Colluding validators could defraud individuals using the currency by conspiring to agree on a fraudulently manipulated version of the underlying ledger.

This is where the danger of new NDCs come in. According to available preliminary plans, most NDCs will feature some degree of ledger centralization, with management powers accruing to the country’s central bank. Take, for instance, the UK’s RSCoin, an experimental cryptocurrency first tested by the Bank of England in 2016 (and planned to be introduced sometime in 2018). Preliminary design plans call for the transaction ledger to be held by the central bank, with individual payments verified by trusted “mintettes” (projected to be large commercial banks). Likewise, preliminary statements made by officials on China’s plans to develop an NDC indicate a strong government presence, to include oversight and control of all transactions made in digital currency. The Venezuelan Petro, which launched in February of 2018 despite unresolved questions about its basic architecture, will similarly feature considerable state oversight. While adopting centralized or semi-centralized cryptocurrency architecture doesn’t necessarily mean that it will be manipulated, it does introduce the technical possibility.

Without open verification of transactions, closed or semi-closed ledgers run the risk of manipulation by a network of validators subject to state power. The Petro in particular illustrates how a centralized ledger could be abused. In a country like Venezuela, which suffers from a high degree of official corruption, the authorities have not shown themselves to be above manipulating exchange rates and taking advantage of the monetary system for personal gain. If validators are linked to the state, it’s not hard to imagine Petros being credited to political allies at below-market prices to be passed abroad as anonymous wealth-transfer vehicles (indeed, a central justification for the Petro is its purported ability to help Venezuela evade US sanctions). A network of validators subject to governmental control or pressure could thus approve transactions which fraudulently conveyed the country’s considerable wealth to offshore accounts. More prosaically, those in charge of the Petro can manipulate the rate at which it is exchanged for oil, since this exchange is to be made through Bolivars (the rate for which is routinely and heavily manipulated by the government). Were Venezuela to adopt an architecture similar to Ripple, a network of chosen validators consisting of state and para-state entities could easily collude to approve fraudulent transactions with the currency.

With centralized ledgers, there would be no way for citizens to police corruption since they wouldn’t be able to verify transactions. Not so the other way around. A government in charge of an NDC with a centralized ledger could design it in such a way as to see a record of all transactions made in the currency, giving it great scope to police the purchases of its population. While Bitcoin provides for an effective degree of anonymity for users, an NDC could be designed in such a way to enforce true-name use only. Indeed, the ability to increase the transparency of transactions so that “everyone’s financial flows and circulations can be seen throughout the whole process” is one justification cited by officials at Chinese state banks for the development of an NDC. And while it would be beneficial to give a well-meaning government the ability to detect transactions by criminals and corrupt officials, in the hands of a repressive or kleptocratic regime, the ability to police transactions becomes another vector for oppression.

Blockchain-based currencies are being actively explored by countries around the globe, but anticorruption advocates should temper their expectations that this will result in radical transparency. While many technical details are still to be decided, the first generation of NDCs will likely boost the state’s control over its finances, enabling more grand corruption in countries already plagued by it, such as Venezuela, and more financial surveillance in countries where the government is looking to exert increased control, such as China. Such statist “centralized transparency” is at odds with the hopes and designs of many cryptocurrency advocates, but it may very well become the dominant story of the blockchain as more countries seek to adopt NDCs.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.