Shamil Zhumatov/Reuters
North Korean leader Kim Jong Un at a wreath laying ceremony at a navy memorial in Vladivostok, Russia, April 26, 2019.
- North Korea, along with Russia, Venezuela, and Iran, have all pursued cryptocurrencies, largely as a means to circumvent sanctions.
- That development illustrates the shortcomings of the board sanctions the US has slapped on those countries and shows why the US's "maximum pressure" can ultimately be self-defeating, writes Willis Krumholz.
- Visit Business Insider's homepage for more stories.
North Korea claims that it is creating its own cryptocurrency. Bitcoin and other cryptocurrency prices fell on the news-at least briefly-because if North Korea is developing its own cryptocurrency, that may reduce its demand for existing cryptocurrency options.
This tells us something about the importance of bitcoin and other cryptocurrencies to North Korea. And American policymakers would do well to understand why North Korea is so heavily involved in these encrypted digital currencies, and the implications of their involvement.
North Korea's new digital currency will be "more like bitcoin or other cryptocurrencies," said Alejandro Cao de Benos, who is both a North Korean official and a Spanish national long fond of the despotic regime.
"We are still in the very early stages in the creation of the token," he added. "Now we are in the phase of studying the goods that will give value to it."
How do cryptocurrencies work?
Normal financial transactions are centralized. When you write a check to someone else, for example, your check is used by that other person's bank to go to the Federal Reserve and withdraw money from your bank's account at the Fed. Because the transaction flows through the Federal Reserve, which acts as an intermediary, this is a centralized ledger: The Fed stands between the two banks and acts as a neutral party in their transactions.
Bitcoin, on the other hand, is a computer code that allows a decentralized payment ledger. Bitcoin's computer code keeps track of who owns what and when all on its own. It does this by incentivizing owners of computing power to "solve" a mathematical equation each time a bitcoin changes hands.
Once that mathematical equation is solved, a new set of code-which says who owns each bitcoin-is added to the previous set of code. This chain of code is called the "blockchain." And because no one person owns or single-handedly tracks the blockchain, the process of clearing and settlement has been democratized, and decentralized.
This accomplishes two things. It removes counterparty risk, so the buyer and seller don't need to trust one another, and it removes third party risk-the owners of bitcoin don't need to trust the computers clearing and settling bitcoin transactions (though bitcoins can still be stolen from an exchange, which is a separate matter).
This decentralization is incredibly valuable to a sanctioned country like North Korea. America's sanctions power flows from the dollar being the world's reserve currency, and the power this gives the American banking system.
Because the US government controls the Fed, which controls the dollar, the US government has sway over a large portion of international transactions. Because doing business with North Korea means getting cut off from access to dollars and the US (and therefore global) banking system, any bank or company wishing to stay above board must avoid North Korea altogether.
Yes, bitcoins can be tracked, especially when sent through regulated exchanges. But it is much harder to track cryptocurrencies than it is to track dollars. And using cryptocurrencies helps North Korea circumvent the American-centric financial system that gives America its sanctions power.
The limits of 'maximum pressure'
That's why North Korea has long used bitcoin to dodge sanctions. For example, North Korea makes money via hacking, and cryptocurrencies help North Korea launder that money and put it to work for other uses. Aside from talking up moves to create its own digital currency, the rogue state held its first ever blockchain and cryptocurrency conference in April. Meanwhile, Russia, Venezuela, and Iran have a similar interest in cryptocurrencies-all for the purpose of sanctions evasion.
The implication for America is that this cat-and-mouse game makes economic sanctions campaigns hard to sustain-and it increases the cost on the US of employing such coercive measures. The more Washington resorts to broad sanctions-not targeted on specific regime officials or entities but at a foreign economy more generally-the more countries like North Korea, and even our European allies, will develop means of evasion.
Aside from this, sanctions are usually ineffective at achieving their desired goals. But the efficacy of broad sanctions is just one reason why Washington should use the blunt force of broad sanctions far more sparingly than it does.
The other reason? US politicians and officials seem to think that using sanctions is a win-win. They are wrong. Over time, sanctions power wanes. Overusing sanctions, especially broad sanctions, encourages countries to build their own institutions and systems outside of America and the dollar. In this way, sanctions chip away at dollar dominance, threatening to severely reduce US power.
There's already proof of this, and cryptocurrencies used by Russia, Iran, and North Korea are but one piece of this equation. Already, China is buying Iranian oil priced in Chinese renminbi (RMB) rather than petrodollars. Russia, while selling China natural gas, has agreed to issue RMB-denominated bonds. And even Europe has examined ways to escape US secondary sanctions to buy oil from Iran, keeping it in the JCPOA.
None of this should be taken to mean the dollar's dominance will soon end-but it won't be the world's reserve currency forever. Abusing sanctions hastens this inevitable decline.
Broad, "maximum pressure" sanctions erode US dominance. Just like using missiles or troops, there are consequences for the overuse of sanctions, often unseen or difficult to measure. Let's hope Washington policymakers figure this out before it is too late.