Author: Santiago Rodriguez Senior is an associate at Uria y Menéndez at their International Arbitration practice group
Digital currencies, such as Bitcoin, are disrupting the world economic order as we know it. The president of the International Monetary Fund recently predicted that, by 2040, digital currencies will create a major change in the banking and financial industries. However, their influence is already palpable. Countries worldwide are beginning to develop the cryptocurrencies of tomorrow. What was previously written off as merely a fad is now considered the future of the global financial system.
Cryptocurrency and the State
While some States have been cracking down on Initial Coin Offerings (ICO’s) and cryptocurrencies, others seem to realize that these technologies might actually be of use to them. States don’t tend to have a problem with the technology inherently, but rather the fact that these are unregulated markets that bypass government regulation. For obvious reasons, States are not fond of this idea.
The way that Bitcoin and other cryptocurrencies work is widely appealing: faster cross-border transactions with very low fees that take place within a secure network that is virtually unhackable. All of these benefits are possible thanks to blockchain technology.
States are struggling to regulate these assets because, by nature, they are designed to work outside the control of government institutions. However, some States are beginning to follow the old adage: if you can’t beat them, join them. These States have realized that new technologies could be an asset for them, and are seeking to apply them to their own fiat currencies.
Transitioning from cash to digital currency could provide States with increased control over how their currency is used, especially in comparison to cash, which can move anonymously. Furthermore, Totalitarian States could build their digital currencies on top of a blockchain that would provide the State with complete oversight over all transactions.
However, it must be understood that, by definition, if States issue their own digital currencies, they are not technically cryptocurrencies. Cryptocurrencies are decentralized by nature, whereas these digital currencies would be issued by central banks and government agencies, meaning that they would be a centralized digital asset. However, for the purposes of this article, we will call these digital currencies Central Bank Digital Currencies (CBDC).
States are struggling to regulate these assets. However, some are beginning to follow the old adage: if you can’t beat them, join them.
CBDC in Action
Countries such as Japan, Sweden, and Norway have stated that they are already developing their own version of CBDC (Block 1). Countries such as Venezuela, Russia, and Iran are developing their own CBDC, as well (Block 2). We separate these countries into two blocks because each block’s approach to valuing their CBDC is different, and will inform the discussion around these assets, especially with regard to how they intersect with investment-arbitration.
Block 1 represents countries with strong economies. In these countries, it will be easy to value a CBDC because the fiat currency is widely trusted, and could be used as the price reference for a cryptocurrency. These countries can simply peg a CBDC to their existing fiat currencies.
However, Block 2 represents countries that have high rates of inflation or have not earned investors’ trust. In these countries, pegging a CBDC to the existing fiat currency would be unlikely to attract investors unless there are changes to the country’s economic policies, or the CBDC is backed by something trusted. These countries are mainly interested in launching their own CBDC to evade economic sanctions or to reshape their image in the eyes of foreign investors. This is why some countries are deciding to use commodities they possess and trade in international markets, such as oil or gold, to set a price for their CBDC.
One example of how this could work is seen in the Petro, Venezuela’s cryptocurrency. The Petro is pegged to commodities—50% is tied to Venezuela’s oil benchmark, and 50% is tied to the combined market price of Venezuela’s diamond, steel, and gold reserves. The idea is to tie the Petro’s price to a “stable” market. While inflation within the country may vary, the international market for these commodities is relatively stable. So, in theory, the price reference for the CBDC would not be tied to Venezuela’s decaying economy but, rather, to the international market.
The Future of Investor-State Arbitration
We foresee that a new form of investor-state arbitration will emerge in response to digital currencies backed by commodities. States that are hostile towards foreign investors—such as the ones in Block 2—may see CBDC as an opportunity to attract investors to invest in their countries using generous incentives—i.e. tax breaks, subsidies, favourable conversion rates to other fiat currencies—while at the same time enticing them with new ways of limiting their sovereign immunity.
These tactics would peg the CBDC to a sovereign asset to later raise public interest or sovereignty defense against foreign jurisdictions, using smart contracts to limit domestic courts as the jurisdiction to settle disputes, or using assets that are only found within their borders to obstruct creditors from executing assets abroad. This is unlike what happens with sovereign bonds, which are usually backed by assets found outside of the country.
However, we believe that investors would still find routes to escape these new constraints and tie States to international courts and/or arbitration tribunals. It is likely that these CBDC, such as the Petro, fit within the definition of investment. Thus, Bilateral Investment Treaties may work as a way to lure States to foreign investor-state tribunals, such as ICSID.
Domestic laws may also exist as an available recourse to broaden States’ sovereign immunity. Also, smart contracts could be built on top of the CBDC blockchain, which could include a specific dispute resolution clause tailored to specific investments, such as for those involving government contracts.
It seems highly probable that CBDC will become a reality. The question is how exactly they will operate.
If countries back their CBDC with a commodity traded in an international market—such as oil or gold—market trust may play a key role in forcing countries to adopt friendlier measures towards foreign investors. These tools will force States to adopt more moderate policies when developing their CBDC, because, if they do decide to adopt a full Calvo Doctrine approach with their CBDC, it will fail, as no investor will take that risk.
This is just a short introduction to what will very likely become a trending discussion within the legal and tech community. It seems highly probable that CBDC will become a reality. The question is how exactly they will operate. The Petro gives us a first glance at the possible pitfalls that these technologies may have if States hostile to foreign investors attempt to use them to their advantage. However, it also gives us a glimpse of the alternative tools that these technologies will provide future investors, and the available resources those investors will have when settling disputes against those States.
Santiago Rodriguez Senior is an associate at Uria y Menéndez at their International Arbitration practice group. He has an LL.B. from Universidad Católica Andres Bello in Venezuela, an LL.M. from Northwestern University focusing in International Arbitration and U.S. Corporate Law, and a J.D. from the University of Miami. Santiago has experience in commercial and investment disputes representing clients in renewable energy, oil & gas, and natural resources industries.
Note: The views expressed by the author of this paper are completely personal and do not represent the position of any affiliated institution.