With the recent announcement from the likes of Elizabeth Warren or Foreign Affairs calling for banning cryptocurrencies, the conversation about the purpose of using cryptocurrencies are heating up, again. The two common themes can be noticed are the illegal use of cryptocurrencies and the dedollarisation effect. While we have repeatedly debunk the former argument, it is adequate for me to add more to the conversation with academic researches so this false fear mongering can be sunk into the deep deep ocean. On the other hand, the latter is relatively new, and I will firstly confess that while I do not have the high level of economic theory, I will do my best to hold a constructive discussion around this with the help of Google and GPT-4.
Image: Banning Bitcoin. Source: Euronews
Claim 1: Illegal activities are the main use of crypto
First thing first, criminals prefer using cryptocurrencies for illegal transaction does not means the only purpose of using cryptocurrencies is for bad purpose. In fact, according to Chain Analysis in the crypto crime 2022 recap, not only the amount of blockchain-related ransomwares attacks decreases in 2022 comparing to 2021, but the crypto scams are also on a downward trend (figure 1). The only reason the total value of illicit activities increase are sanctions, meaning the political conflicts among Russia, USA, EU and North Korea. Therefore, blaming cryptocurrencies enabling bad actors is a false argument, as it is only the second-hand aftermath from those politicians agendas. In fact, if we go further back to 2017, the illicit share of criminal activities on total blockchain transaction volume have never went over 2% (figure 2). This is outcry fewer than the 2-5% estimated of global GDP connected with money laundering and illicit activity, according to UN.
Figure 1: crypto crimes break down by categories. Source: Chain Analysis
Figure 2: crypto crimes share of all transactions. Source: Chain Analysis
Now, let's discuss the "anonymity" ability of a few famous blockchains, namely Bitcoin, Ethereum and Monero, that anti-crypto people are accusing. Since the heat of AI is red hot at the moment, let us have a look at the 2019 research "Regulating Cryptocurrencies: A Supervised Machine Learning Approach to De-Anonymizing the Bitcoin Blockchain" to see if Machine Learning can helps classifying and detecting bad actors. The authors' aim was to categorize Bitcoin addresses using supervised machine learning to find out those used for illegal activities to help regulators and organizations make informed regulation and compliance. They applied various supervised ML techniques like K-Nearest Neighbors (KNN), Classification and Regression Trees (CART), AdaBoost Classifier (ABC), Gradient Boosting Classifier (GBC), Random Forest Classifier (RFC), Extra Trees Classifier (ETC), and Bagging Classifier (BGC) on a sample of 957 entities with ~385 million transactions among 12 categories. The evaluation was done using precision, recall, F-1 score, and support. They achieved the highest model with a mean cross-validation accuracy of 80.42% and F1-score of 79.64% with the Gradient Boosting algorithm. Thus, it can be said with high confidence that Bitcoin is traceable from Machine Learning's point of view. In figure 3, the total shares of illegal transactions are less than 6%, shaking the belief of using cryptocurrencies are for bad actors only.
Figure 3: classification result from Bitcoin transaction analysis in 2019. Source: Regulating Cryptocurrencies: A Supervised Machine Learning Approach to De-Anonymizing the Bitcoin Blockchain
As for Ethereum, we can learn more about tracing it from the 2020 paper "Blockchain is Watching You Profiling and Deanonymizing Ethereum Users". In this paper, the author examined if privacy-enhancing techniques on Ether are helpful while also applying Danaan-gift attack on the chain, which you can understand as a Trojan-horse-ish kind of attack. From the public available sources of transaction data like Humanity DAO or Tornado Cash mixers, the study indicate that Tornado Cash Mixers do not provide as much anonymity for lower values. In fact, they were able to link 30.3% of deposit under 1ETH with withdrawal addresses, while only 13.4% for deposit from 10ETH to 100ETH are identifiable (figure 4). In general, as you can guess, majority of transactions around the world is much less than this amounts and thus has 43.4% chances of being identified. The Danaan-gift attack has a success probability comparable with that found in Zcash with 39.9% success rate for transactions under 100ETH. This is remarkable, as for context, average transaction value for American Express are 141 USD in 2016 based on Statistica, while 100ETH is over 160k USD as of today. Therefore, this also makes the band and arrest of Tornado Cash Mixers's creator due to the service being used by cybercriminals associated with North Korea even more political-based, as clearly majority of transactions proceed by Tornado Cash Mixers are well below 100ETH.
Figure 4: result of the tracing algorithm. Source: Blockchain is Watching You Profiling and Deanonymizing Ethereum Users
Regarding Monero, as there are a few new critical upgrade since 2019 on its mechanism, there are not many papers examining its architecture. Thus, we will look at it by using network analysis. The paper "Deanonymization and linkability of cryptocurrency transactions based on network analysis" published in 2019 perform network analysis on Bitcoin, Dash, Zcash and Monero. The result showed that by using cluster heatmap, the authors was able to narrow down the location of the original IP for all four cryptocurrencies. In three out of four experiments with Bitcoin, the correct IP was obtained in the top 5 most likely originator IPs. Zcash had a similar anonymity degree as Bitcoin, but on a much smaller scale of network. Dash performed two clustering algorithms, one with only transaction inventory messages and one with additional transaction inventory messages. In both cases, the cluster heatmap was able to clearly narrow down the location of the original IPs. Monero imposed restrictions on locked transactions for 20 minutes before broadcast to the network, making it unrealistic to perform previous clustering algorithms with their own issuing transactions. Thus, clustering was done on existing transactions in the network, which showed a less clear picture compared to Bitcoin. However, as can be seen from figure 5, we can still clearly narrow down the source of the originator.
Figure 5: Cluster heat map of IPs performing on Monero. Source: SemanticsScholar
Thus, from what we have seen, by using various analysis technique, cryptocurrencies are proved to be traceable, if not more than traditional monetary systems where ledgers are privately held. However, the brutal transparency of cryptocurrencies are difficult to overlook and not comfortable for traditional banking systems to adapt. It does not make sense for an outright ban as it just shows the lack of effort in understanding new technology and political-steaming reasons from those regulators, such as saying the "popular thing" to get donation for election campaign.
Claim 2: Cryptocurrencies has the de-dollarisation effect
Dedollarisation is a term used to describe the process of countries reducing their reliance on the US Dollar (USD) as the primary currency for international trade and finance. This phenomenon has gained momentum in recent years, with the rise of alternative currencies such as Bitcoin and the strengthening of the Chinese Yuan. With the help of GPT-4, we will explore the claim that Bitcoin is contributing to dedollarisation from the Foreign Affairs and whether this poses a danger, as well as the increasing influence of the Chinese Yuan and its alliances with countries like Brazil, India, and recently Saudi Arabia with ASEAN members.
Figure 6: the BRICS members. Source: Wikipedia
Bitcoin, a decentralized digital currency, has gained popularity as an alternative to traditional currencies due to its transparency, particularly the USD. Its proponents argue that it has several advantages, such as its immunity to government censorship, inflation-resistant nature, and lower transaction costs. These factors have led some to claim that Bitcoin could contribute to the dedollarisation effect. For example, as mentioned above from Chain Analysis report, we witnessed a significant increase in sanction-related transactions in 2022, in particular Russia. Other countries under US sanctions, such as Iran, Venezuela, North Korea, and Cuba, could use Bitcoin to circumvent the restrictions imposed on their access to the global financial system and trade with other countries that are willing to accept it. For instance, Iran has reportedly been using Bitcoin to pay for imports from China and Turkey. What if other countries using Bitcoin to pay for Russia oil over the price cap imposed by the US? It will not only effectively reduce US dollar importance on the global market, but also the States's influence on allies countries. This is already in progress as Japan broke it recently.
That being said, there are also significant challenges that may limit their potential to drive dedollarisation. Some of these challenges are:
Volatility: The value of cryptocurrencies, including Bitcoin, tends to be highly volatile. This volatility can deter businesses and individuals from using them as a reliable medium of exchange or store of value, limiting their impact on dedollarisation. For example, according to CoinDesk, Bitcoin's price fluctuated by more than 50% in 2021 alone, reaching a high of over $60,000 in April and a low of below $30,000 in July. Such swings can make it difficult to plan and execute cross-border transactions using cryptocurrencies. In fact, according to the Gresham's Law, a principle in monetary economics, states that "bad money drives out good". In the context of cryptocurrencies, this means the high volatility of cryptocurrencies may result in the preference for CBDC version of stable coin, which is backed with real assets like USD or gold, hindering their ability to promote dedollarisation and even increasing the power of USD influence on world trade.
Regulatory Uncertainty: Governments and regulatory bodies around the world have yet to establish comprehensive regulatory frameworks for cryptocurrencies. This uncertainty may hinder widespread adoption and limit their potential to drive dedollarisation. For example, according to Cointelegraph, some countries have banned or restricted the use of cryptocurrencies, such as China, India, Turkey, and Nigeria. Others have imposed strict rules or taxes on cryptocurrency transactions, such as South Korea, Japan, and France.
Scalability and Infrastructure: To facilitate a truly global shift away from the USD, cryptocurrencies must overcome scalability and infrastructure challenges. While significant progress has been made in recent years, more work is needed to ensure that cryptocurrencies can handle large-scale international transactions efficiently. For example, according to Crypto.com, Bitcoin can only process about seven transactions per second (TPS) and Ethereum is only slightly better at 20 TPS, compared to Visa's upto 65,000 TPS potentially. Moreover, cryptocurrency transactions require high amounts of energy and computing power, which may pose environmental and security issues. Even if the scaling tps are being addressed, the gas price for each transaction is still too high compare to traditional banking system, with Ether gas price ranges from 3-10 USD per transaction.
It is a mistake to not understand the Chinese Yuan roles when we are discussing the dedollarisation trend. The Chinese Yuan has made significant strides in asserting itself as a viable alternative to the USD. Recently, China has forged alliances with countries like Brazil, India, Saudi Arabia, and the ASEAN members, encouraging them to adopt the Yuan for foreign exchange transactions. In fact, the newly alliances BRICS just overtook the declining G7 in term of global GDP.
Figure 7: The dedollarisation leads by China and Russia. Source: Financial Times
On the international market, China has been trying to dethrone the USD for a long time. They has established bilateral currency swap agreements with numerous countries, allowing them to exchange their currencies directly without having to use the USD as an intermediary. This reduces transaction costs and promotes the use of the Yuan in international trade and finance. Moreover, instead of using the SWIFT system, partners nations can also use China’s Cross-Border Interbank Payments System for transaction. This is one of the main concern for Chinese Yuan to overtake USD as the world default currency for foreign exchange.
Another notable effort from China is the formation of The Belt and Road Initiative (BRI) in 2013. China's ambitious infrastructure project aiming to connect Asia, Europe, Africa, and Latin America through trade and investment, the BRI, has further promoted the use of the Yuan in international transactions. Many countries participating in the BRI have adopted the Yuan for trade and investment, contributing to the currency's growing influence.
Figure 8: USD and YUAN. Source: Global Trade Review
Therefore, as can be seen, while Bitcoin does possess some attributes that may contribute to dedollarisation, such as decentralization, limited supply, and increasing international adoption, its impact is likely to be limited in the short term. In contrast, the Chinese Yuan, backed by a large and growing economy, has made significant strides in reducing global reliance on the USD through currency swap agreements, the Belt and Road Initiative, and the internationalization of its currency. The fact is that the Foreign Affairs agency should be focusing on stabilizing the power of USD against recent international movement from China and Saudi Arabs rather than worrying over cryptocurrencies, even if they acknowledge crypto currencies as a type of currency in the first place.
Conclusion
In conclusion, the debate surrounding the potential ban of cryptocurrencies, their role in illegal activities and dedollarisation has become increasingly heated. While cryptocurrencies have faced criticism for their use in illicit transactions, recent studies have demonstrated their traceability, debunking the myth that they are solely utilized for nefarious purposes. As for their potential impact on dedollarisation, cryptocurrencies do possess certain attributes that could contribute to this trend, but they also face significant challenges such as volatility, regulatory uncertainty, and scalability limitations.
On the other hand, the rise of the Chinese Yuan and its growing influence on the global stage through alliances, currency swap agreements, and initiatives like the BRI should not be overlooked. As we move forward, it is essential to focus on understanding and addressing the true drivers of dedollarisation and to avoid placing undue blame on cryptocurrencies. Rather than proposing outright bans, regulators should work on developing comprehensive regulatory frameworks that promote transparency, security, and innovation in the cryptocurrency space, while also considering the broader geopolitical and economic factors at play in the global financial landscape.
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