Maduro's crypto end run around US sanctions is a fool's errand

Maduro's crypto end run around US sanctions is a fool's errand
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Mired in a self-inflicted crisis resulting from years of economic mismanagement, Venezuela thinks it has found a miracle cure: creating a new digital currency backed by oil. But this new currency, appropriately called a “petro,” is likely to prove itself fool’s gold. It is more likely to further debase the country’s financial standing and its credibility.

Venezuela’s problems cannot be made to vanish by a trendy new technology that has still not proven itself in the world of finance.

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These issues include years of excessive spending paid for by printing money, leading to hyperinflation so severe that Venezuela cannot even afford to purchase the banknotes its people need to make purchases with the national currency, the bolivar.

 

Default on its ballooning debt appears imminent, and sanctions make it difficult to transact with other players in the international financial system.

In creating this new petro, Venezuela seems to be wanting to learn from its people. Venezuelans trying to avoid the bolivar have tried to get a hold of digital currencies, like bitcoin, as a safer store of their wealth.

This new breed of currencies is difficult to control because they are backed by computer code instead of a government, and anyone can transact with them online without dealing with regulated intermediaries like banks.

Now, Venezuela’s government thinks that if its people can use digital currencies to evade its controls, it can use its own digital currency to evade U.S. sanctions. The government hopes the plan will also allow it to cash in on the global trend that has seen billions of dollars easily raised by issuers of new digital currencies, often backed only by vague plans and code.

Venezuela’s government hopes that each unit of its petro will be valued because it is supposedly backed by a barrel’s worth of Venezuelan oil. To that end, the government will accept petros as payment for taxes and encourage others to accept them too.

Like many other digital currencies, individuals will be able to buy and sell petros through online exchanges and hold them on their computer rather than in a bank. The goal is for Venezuela to allow its oil to be monetized and traded without moving the underlying oil.

One of the problems is that, however logical this gambit is in theory, the rushed plan coming out of Caracas is unlikely to work due to technical challenges and a lack of credibility.

The basic advantage of these new currencies is that the rules governing them are contained in computer code all participants can see, and all transactions are broadcast to the entire network for verification to ensure its security.

The problem is that errors in the code everything is built on can have drastic consequences, and the rush to develop the petro in only three months (it was announced only in December 2017) means that it will likely be susceptible to hacks that could wipe out its value.

It also changed the digital currency standard it will follow for its code at the last minute, pivoting from the most common (called ERC20) to another that was recently involved in a $500-million hack. These standards have radically different implications for how the petro would work and demonstrate how rushed the project is.

Even the best code, however, would not solve the credibility problem. Code could make it impossible to mint more digital petros, but it does not solve the older problem of debasement. For millennia, sovereigns inflated away debts by reducing the amount of precious metals like gold in their coins.

Venezuela could follow their lead, selling off the oil or pledging it for loans from China. Since there is no way to convert petros into oil, there is no mechanism to keep the government accountable for the supposed backing.

A change in power in Venezuela could also lead the petros to be invalidated as a currency, as members of the political opposition have denounced the initiative. Thus, a rational investor should be willing to pay only bargain prices for petros.

While it may yet raise a good amount of money from the type of digital currency investors who have put hundreds of millions of dollars into even more harebrained initiatives than the petro, the scheme is most likely to serve primarily as a costly distraction.

Venezuela may go down in the history books as the first government to issue its own digital currency, but it will remain in dire economic straits. Trendy technology is no substitute for prudent fiscal policy and good governance.

Martin Chorzempa is a research fellow at the Peterson Institute for International Economics in June 2016. He gained expertise in financial innovation while in Germany as a Fulbright scholar and researcher at the Association of German Banks.