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Digital currencies and Diplomacy: challenges faced by the international system

Digital currencies and digital -assets represent the most important financial and digital revolution of the latest decade. It allows for a decentralized financial system making financial transactions easier and more appealing. But can they also represent a tool (or a threat) in the arena of diplomacy and international security? The answer is yes.

First, they may pose a challenge to the U.S. hegemony connected to the use of the U.S. dollar as a global currency reserve. Secondly, states under a sanction regime may use digital currencies to evade international economic sanctions. Economic sanctions are the principal instrument used by states and international organizations, in particular, the UN, to put pressure on rogue states and individuals to tackle illegal behavior or attempt to change it.

The importance of economic sanctions has become manifest in the current status of international relations and European history with the aggression by Russian troops on Ukrainian territory and sovereignty. There exist the possibility for Russia and other states to avoid the imposition of sanctions and the exclusion from the international system of payments through the use of digital currencies. Digital currencies are defined as virtual currencies not backed by real currencies or central authorities. The peculiarity of such currencies consists of a decentralized system with no single institutions with the authority and the power to manage them or impose a particular market value, which only depends on the credibility of the asset and the trust of investors. The second main aspect is the quasi-anonymity they possess.

For instance, public addresses associated with Bitcoin accounts make it possible to know who is receiving or sending the transaction but no identifiable information about the actors involved is delivered. Digital currencies are created through a process called mining which is achieved with the use of supercomputers and electronic equipment which are often deemed of being unsustainable due to the large amount of energy they require. Notwithstanding the prevalence, they have reached digital currencies remain, however, a wealth reserve and are not considered a standard means of payment. Therefore the question is how can digital currencies undermine U.S. hegemony. Part of the geopolitical influence the United States has on the international community is closely connected to the use of the U.S. dollar as a global currency reserve for international trade, as it was agreed upon at the Bretton Woods agreements in 1944. That allows the U.S. to never suffer from a balance of payment crisis.

However, the dominance of the dollar is challenged, on one side, by the attempt of China to detach from the dollar for international payments and the increasing attractiveness of the Euro as a global reserve. On the other hand, digital currencies play an important role in this respect. First of all, a decentralization of technology may bring with it a multi-polarisation of power and influence on the economic and therefore the diplomatic side. The evolution of digital currencies may reduce the influence of the dollar and become a substitute in financial markets, resulting in increased costs to borrow dollars, which would be detrimental to U.S. debt and its diplomatic influence. This is even more true considering that many Latin American countries have followed El Salvador in adopting Bitcoin as a legal tender and the attempts of Russia to develop a national digital currency and China’s interest in the issue. However, few believe that dollar supremacy could be seriously endangered.

The second, and most important, aspect of the geopolitics of digital currencies is the possibility for states to evade sanctions. Notable examples are the endeavor of North Korea to avoid U.S. sanctions through cyber attacks on digital exchanges and digital ransomware, among other things. Digital currencies also play an important role in the Ukrainian invasion, with Ukraine’s use of digital assets to purchase weapons and the Russian attempt to avoid sanctions. In particular, regarding convertible virtual currencies, the U.S. financial institutions have been advised through some red flags on the possibility of illicit transactions by Russian individuals and entities to circumvent the sanction regime. The European Union for its part is making sure that Russia may not avoid sanctions through the use of digital currencies in its package of sanctions and the sixth AML directive concerning also digital currencies.

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