Venezuela is being strangled by hyperinflation, joblessness, insolvency, corruption, and sanctions imposed by the US government. It has also been suspended from the South American trading bloc Mercosur over the undemocratic practices of the Nicolas Maduro government, among other reasons. To loosen the grip of its economic and humanitarian crisis and escape the effects of sanctions, Venezuelan officials have hit on a novel approach. They have decided to take advantage of new financial technologies to create a brand-new supposed cryptocurrency dubbed the “petro.” This step is certainly innovative, but there are many reasons why it is unlikely to work.
Among the many possible reasons for the currency move is the hope that Venezuelans who no longer wish to hold the country’s currency, the bolívar, will decide to hold the new currency as a safeguard against hyperinflation. Perhaps more salient, the Maduro government hopes to circumvent financial sanctions by introducing what it calls a cryptocurrency. Venezuela’s actions may constitute the first time that an insolvent country has seized on new fashionable technology such as bitcoin-like currencies to try to avert the fallout from macroeconomic calamity. Inadvertently, however, Venezuelans may be providing a lesson to the rest of the world about the use of cryptocurrencies, notably that they ultimately rely on trust and credibility, both attributes that the Maduro government does not have.
Accordingly, the December 3 announcement that the government would launch its own cryptocurrency should be viewed as a thinly veiled PR stunt with potentially perverse global implications, especially if corrupt dictators and other targets of sanctions, including North Korea, exploit the same gambit. The threat of such countries using cryptocurrencies to smuggle their ill-gotten gains out of the country without risking confiscation, all while most of their populations are stuck with their nation’s worthless fiat currency, is very real. As the name implies, the petro is to be a digital cryptocurrency backed by Venezuela’s natural resources, mainly oil, but it could protect regimes from the consequences of looting resources in their own countries.
Will this gambit work? One reason it may not is the Maduro government lacks basic trust, an issue cryptocurrencies cannot resolve. Without trust, decentralized cryptocurrencies cannot serve as a medium of exchange, unit of account, or store of value.
The Maduro government lacks basic trust, an issue cryptocurrencies cannot resolve.
Venezuela is currently in the throes of hyperinflation due to years of macroeconomic mismanagement and printing money to finance growing budget deficits. In these circumstances, citizens usually find an alternative currency to preserve their savings—or to use as a store of value. In past Latin American hyperinflations, such as Argentina’s in the 1980s, the dollar emerged as the natural currency to protect savings from the loss in values caused by hyperinflation. Venezuelans, however, lack the ability to use the dollar in this manner. The greenback is scarce both because of the need to pay off the country’s enormous debt and because of recently imposed US sanctions. Sanctions have greatly diminished Venezuela’s ability to extract dollar revenues from its oil exports. These difficulties have led many Venezuelans to flock to cryptocurrencies like bitcoin for protection against inflation.
Maduro appears to want to capitalize on this flight by providing citizens with yet another digital currency to hold. Ironically, calling the scheme a “cryptocurrency” backed by natural resources exposes just how little thought and expert consultation went into this announcement: Nothing in the announcement suggests anything cryptographic. What makes bitcoin a cryptocurrency is the cryptographic puzzle one needs to solve to “mine” it (the process by which new bitcoin are made and transactions are cleared) and the ways transactions are signed with cryptography. Maduro’s scheme seems to involve simply creating a digital asset linked to the products of physical mining but appropriating the term cryptocurrency to generate excitement and attention.
Because transactions in cryptocurrencies do not go through the normal channels of international payments systems, such as clearing houses and bank accounts, they are harder to block under imposed sanctions. Users around the world have raised billions of dollars through initial coin offerings (ICOs), often with only a few developers, a white paper, and some code. Venezeula’s leader may believe that he should be able to raise more than a typical ICO, considering that he can offer both the code and physical commodities with real world value—in the form of oil, gold, and diamonds, as announced.
Trust is central to any form of currency whose users want it to be an effective means of exchange, unit of account, or store of value. But for decentralized cryptocurrencies, for which there is no government or treasury backing, trust is even more relevant. In fact, the central innovation of bitcoin is its distributed ledger made up of chains of transaction blocks, which has allowed the transfer of bitcoin between parties who do not trust each other. Since there has been no centralized entity controlling the creation of bitcoin, no entity could suddenly run the printing presses and erode its value by flooding the supply.
The problem, though, is that this system on its own can only enable trustless donations of bitcoin. Bitcoin is only as valuable as the dollars, gold, or goods and services that it can be used for purchase or sale, and the link to those values relies on users' trust in their counterparties or intermediaries.
The “petro” is supposedly “backed” by Venezuela’s rich reserves of oil, gas, gold, and diamonds, an arrangement that mimics currencies backed by gold reserves. But such “backing” has only been credible when the currency could be redeemed at a fixed rate for gold. Over the years, crises of confidence in that backing have led to massive redemptions followed by depreciations. In Venezuela today, hyperinflation indicates that lack of trust in the government is already underway.
Would there be a way out for Venezuela? To get the petro off the ground, the currency would need some sort of bitcoin-like protocol that ties the government’s hands, fixing the issuance schedule outside its whims. But even if the government were somehow able to create an ironclad technical system for token issuance and transfer, the currency’s value would depend on the amount and value of the resources backing it. Leaving aside Venezuela’s credibility problems, finding such a formula would be incredibly complex. Thus, the interaction between the cryptocurrency and the real world is where the scheme completely breaks down.
To make matters worse, much of Venezuela’s resources used to back this new currency have already been promised to China and other lenders in the form of bonds backed by oil. It would take a giant leap of faith for investors to trust that the resources backing their petros were not already promised to other creditors, or that these resources even exist in promised quantities in the first place. In addition, Venezuela would have to grant redemption rights to trade petros to the issuer in exchange for the physical resources. Petro holders would need to rely on Venezuela’s shaky legal system for enforcement of their claims to redeem their holdings for any of the underlying assets, an unlikely proposition. Nothing would stop the government from defaulting on its redemption obligation, just as it has stated it intends to do with its bonds. The value would collapse, but undoubtedly after connected officials sold their holdings for cryptocurrencies they trust.
So how can an untrustworthy government with a serious hyperinflation problem issue a backed cryptocurrency? The short answer is: It simply can’t.
1 In a typical ICO a percentage of a newly issued cryptocurrency is sold to investors in exchange for legal tender or for other cryptocurrencies such as bitcoin.