2017 November 6 - Volume.1 Issue.2

2017 November 6 - Volume.1 Issue.2

Government Digital Currency Could Address Russian Shadow Economy

Russia is planning to issue a government-backed digital currency, the CryptoRuble. It will not be mined but rather issued by the Central Bank. While details are scant, its value will be pegged to Rubles, which will aim to be a stable digital medium of exchange. CryptoRubles will not be private or resistant to inflation but they can present an opportunity for the government to tax the underground economy by slowly phasing out cash.

Vladimir Putin has officially given presidential orders to Prime Minister Dmitry Medvedev, and the Central Bank Governor Elvira Nabiullina, to create a framework that will regulate cryptocurrencies in Russia. The regulations will pertain to the legal status of cryptocurrencies “based on the obligation of the Ruble as the only legal tender in the Russian Federation”, the official document stated. The Initial Coin Offering (ICO) process will be evaluated and appropriate regulations will be determined. Russia also intends to tax miners and make their registration to authorities mandatory. And, Putin has gone further and requested the apparatus to establish a “single payment space” within the Eurasian Economic Union.

Russia has had a rocky relationship with cryptocurrencies. Just last year, the Russian Finance Ministry was considering a legislation that would make the use of digital currencies illegal with fines as high as 2.5Mn Rubles (Approx. $42,000) and prison sentences of up to seven years citing the risks of money laundering and other criminal activities.

In June, Mr Putin met with Ethereum founder Vitalik Buterin to discuss Ethereum’s potential to diversify the Russian economy beyond oil & gas and to discuss the potential implementation of Blockchain technology in Russia. Two months after the meeting, a consortium of the country’s biggest banks led by Russia's two largest financial institutions VTB Group and Sberbank, developed a Blockchain solution dubbed Masterchain, based on an Ethereum protocol, which complies with the security standards and is supported by the Central Bank. The project's goal is to innovate the undeveloped banking market in Russia. It should improve the exchange of information about the customers and transactions between banks while increasing the security and transparency.

On October 10, state-owned RT reported that Mr Putin has taken a stand against cryptocurrencies in general because of their unregulated nature. He cited the reasons as “opportunities to launder funds acquired through criminal activities, tax evasion, even terrorism financing, as well as the spread of fraud schemes.” He furthered his concerns about determining liability if any problems were to arise because decentralized cryptocurrencies are “issued by an unlimited number of anonymous sources”.

Russia’s increased activity in the cryptocurrency space and the recent banking innovation efforts are going hand in hand with the reports that Putin approved a development of a state-controlled cryptocurrency. According to local news sources, in a closed-door meeting, Mr Putin officially stated that Russia will issue its own cryptocurrency dubbed ‘CryptoRuble’. The details still remain to be seen but Nikolay Nikiforov, Minister of Communications and Mass Media of Russia, disclosed that CryptoRuble will not be mined but rather issued by the authorities. The cryptocurrency will be pegged to a fiat Ruble and interchangeable at any time thus instantly making it extremely stable in terms of other cryptocurrencies, which still suffer from high levels of volatility (See Graph 1 & 2.)

Nikiforov also added that any realized profits obtained by trading the cryptocurrency will be taxed at a common 13% income tax rate. Russia is also planning to introduce a controversial 13% tax on CryptoRubles when the owner is unable to explain the source of his CryptoRubles. Nikiforov concluded with: “I confidently declare that we run CryptoRuble for one simple reason: If we do not, then after two months our neighbors in the Eurasian Economic Union will.” In fact, Kazakhstan, one of the members, also announced that they plan to launch a state-issued cryptocurrency, which will be backed by fiat.

“Your Keys, Your Bitcoin”

Money cannot be seized on a decentralized network if users hold their own private keys. But there are users, which use bitcoin because of its practicality - cryptocurrencies are capable of fast, cheap and borderless money transfers while not relying on a third party. For users that are looking solely for practicality, a stable government-backed cryptocurrency will be a welcomed option.

CryptoRubles, and other government-backed cryptocurrencies, can potentially present a problem for financial institutions as users can store their funds on their digital wallets instead of a checking account. As this then will be legal tender, governments will require all merchants to accept cash along with the new digital currency.

Russia has a huge underground economy, which results in a massive amount of unrecorded and thus untaxed income for the government (Graph). By having a state-controlled digital currency, the government will be able to slowly start phasing out cash, which will allow for a better control of where the money is going and will consequently increase their tax income.

The government will have a direct oversight of money flows with better control of capital flight without the necessity to request information from third parties such as banks or card issuers.

1: Absolute Returns US Dollar / Ruble (2015-To Date)

2: Absolute Returns US Dollar / Bitcoin (2015-To Date)

Russian Shadow Economy: $500Bn In Untaxed Revenue

Source: Association of Chartered Certified Accountants

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Assuming that Russia wants to tackle their enormous shadow economy, it’s also probable that the government will have the digital wallets directly connected to a physical identity.

In decentralized cryptocurrencies, the exchanges must perform the necessary Anti-Money Laundering (AML) and Know-Your-Client (KYC) checks because governments have no authority or power to regulate the decentralized cryptocurrencies.

When the cryptocurrency is controlled by the government, the most effective way would be to connect each wallet to a government ID and thus have all the transactions linked to identities only visible to them.

Moreover, even widely-used cryptocurrencies such as Bitcoin are having difficulties in being accepted by a lot of merchants. Merchants are not motivated to accept them because of the volatility and uncertainty regarding future regulations.

Another potential advantage will be the ability for non-Russians to use CryptoRuble as a tether in between their own cryptocurrency trades in uncertain times. This would be the first time that a real foreign currency backed by the government was tradable on cryptocurrency markets. By increasing the foreign demand for rubles, its value may increase.

Russia is attempting to issue their own cryptocurrency to take back the control that they are losing. By combining the strengths of conventional cryptocurrencies such as transaction speed and low-cost combined with an increased oversight of money flows, there is potential for this project to be successful. Russia could increase their tax income and set a precedent for other governments that are struggling to figure out what to do.

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