Russia, Singapore, and China are developing national cryptocurrencies - here's an in-depth look into what to expect next.

Note: this post assumes some knowledge of blockchains, tokens, and smart contracts. For background reading, try this primer on blockchains and then this primer on tokens.

With the news that Russia, Singapore, and potentially China are working on tokenizing their fiat currencies (though I’m not sure that report on the “Chinese Royal Mint” has been cleared up quite yet), we’ve caught a glimpse of what the world might look like if states actively pursue blockchain ecosystems: each country possessing its own digital token and private chain.

What begins with tokenization could, eventually, end in a series of self-contained, on-chain national economies — what I am calling “hosted economies” until a better term comes along.

Russia, for example, might migrate its economy to its own private blockchain, with its own token (the digital version of the ruble), transaction history visible to the chain owner (the Kremlin), and smart contracts and transaction policies that are immune to outside interference. Permissioned government institutions would be able to set the terms of trade, taxation, and many other economic options for the entire chain. A second country, like Singapore, might likewise transition to its own private blockchain. The two chains may then integrate via sanitized input/outputs like any pair of applications on your computer. The killer apps for blockchains are countries.

The pressure on states to adopt private chains will be strong. Experiments like Bitcoin and Ethereum, and especially more price-stable cryptocurrencies like USDT and Corion, have proven that users are prepared to give digital tokens a value and exchange these tokens as though they were money in return for goods and services. This presents what might ultimately be an existential threat for governments — untaxable transactions. If public participation in blockchain token trades (effectively an underground market) grows rapidly, this will pose an economic crisis as everyone defects to the new, taxless system. If states find themselves unable to tax most monetary transactions, they will collapse under revenue drought.

The only way to address this threat is to either:

1. cut off public access to public blockchains (and, if traffic is encrypted, this can only be done by eliminating encryption or the internet itself), or to
2. create a private blockchain and capture most of the commercial sector early, before industry has time to develop a robust competitive system.

Because the internet is a critical economic resource, and encryption is a essential component of the internet, most countries will decline the first option. Some countries have gone so far as to ban fiat-cryptocurrency exchanges, but this is ultimately ineffective as long as citizens can send funds out of the country to foreign exchanges (which is also very, very difficult to restrict).

The second option, the creation of a national private blockchain, is more palatable and might even be desirable to governments (as will be shown later). Deployment of a private blockchain can prevent mass migration to a public chain by virtue of relatively simple transaction analytics. Any users accumulating tokens via the private chain but trading them in bulk for outside tokens may be easily identified and punished by the chain owner, incentivizing participation in the private chain or approved public chain vendors.

For example, the United States might see that an employee, John Doe, receives USD tokens from his work. John is then on record trading these tokens for public tokens (say, Bitcoin) through an unapproved vendor. This demonstrates John Doe is making further transactions outside of the state chain, and if he does not file taxes for external transactions roughly equal to the USD tokens he traded initially, he can be flagged as a possible tax evader and investigated (and perhaps fined). Another option available to states is to simply white list approved currency vendors whom the government trusts to collect taxes on behalf of the state. Either way, by mandating that the bulk of personal income is provided in private chain tokens, a state can incentivize general use of the private chain rather than public chains.

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Now that we’ve seen the pressures that might drive states to establish hosted economies, we move to the meat of this post: what possible outcomes can we expect?

In short, the adoption of private national blockchains, smart contracts, and fiat tokens could immensely disrupt the world’s financial and political sectors by

1. boosting government oversight of all economic activity in their respective blockchains to near-omniscient levels,

2. increasing public trust in governance, commercial, and non-profit institutions by exposing their inner workings through necessarily-transparent smart contracts, and

3. streamlining economic services and political relations through automatic smart contracts and credible escrows.

The online literature on what repercussions one can expect in the long term from blockchain dominance has been surprisingly scant, so I would like to suggest some possibilities.

• Most states (where possible) will tokenize their fiat currencies. Tokenization would provide immense value to states, for one chief reason: all transactions made with tokens would be quick, verifiable, transparent, and most importantly, instantly taxable. Tokens would essentially eliminate tax evasion and make the process of taxation much easier. Imagine the IRS: “Oh, I see you sold ten shares of Apple on this NYSE smart contract. I’ll go ahead and collect capital gains.” This could happen automatically — with no additional reporting needed, nor any tax return filed — simply by adding a line of code to a smart contract:

// this is pseudo-code
// send capital gains tax to IRS
trader_account.send(gains * tax_rate, trader_id, IRS_address)

• Your average citizen won’t immediately notice the transition. A majority of transactions in the United States are already cashless (via PayPal, your bank, or some other digital intermediary). While retooling the financial sector to use tokens will be an immense effort, at the end of the day your average citizen would see $3,402.28 in their bank account before and after tokenization. They would not feel the difference except perhaps for possibly an inflation wobble as the token market volume grows to match off-chain transaction volumes. Nor will current crypto esotericisms like wallet address and private keys be visible to future users — any crypto accounts would be held invisibly by banks, and the only “address” you might see is your account and routing numbers, just like always.

• Every state will continue to exert complete control over its fiscal policy (excepting international organizations like the EU, which may opt for a single chain, or twined chains, for its member countries). Inflation, interest rates, and taxation levels will be entirely managed by the state, as has always been the case.

• National blockchains will be able to integrate with other national chains. The legal knowledge required for trade can be greatly simplified by standardizing international smart contracts which automatically take into the account restrictions, fees, tariffs, and taxes of both nations. This may be both an boon and a curse. On the one hand, traders can get a preview of exactly how much a transaction will cost them; they can also trigger trade transactions immediately, without waiting for teams of lawyers or payment processors to confirm the transaction. On the other hand, this functionality would enable countries like China to insta-block transactions with any nation or organization they’re currently sanctioning — or even the unregulated public blockchain on which the more libertarian or global-facing technology may live.

• Some states may opt to roll out digital national identity “cards.” This will be very contentious. The blockchain makes identity management easy. With mandatory ID accounts, states can easily tie every transaction to a registered user or organization, ensuring no transactions are made without the necessary permissions. Foreigners could not submit donations to domestic political organizations; minors could not enter into adult-only transactions; government officials’ transactions could be easily audited; voting could be easily implemented. Worryingly, all blockchain activity could be easily monitored, collated and used against citizens if states do not implement appropriate oversight. States that implement a layer of obfuscation between account and person would be safer, but watchdogs should be vigilant. Ideally, public oversight groups would be included in the initial design of these chains.

• Open-source economic and political systems might be developed by teams of political scientists, blockchain developers, and smart contract developers, which could in turn be adopted by new or transforming states. Countries with no history in governance will have instant access to a full set of default laws and institutions, with toggleable modifiers allowing these templates to conform to native predilections. Competition to develop the best economic template will be fierce, and individual features (commercial tax rate, for example) may be adopted and discarded easily. Want a command economy? Here you go. Want a laissez faire economy, with no corporate tax but a high income tax, and maybe a first-past-the-post voting system for your government leadership? Here’s your template.

• The public blockchain(s), which “surrounds” the bubbles of private national chains, will be part Wild-West smart contracting — full of black markets and launderers — and part global commercial ecosystem. Imagine for a moment if Google wrote a few smart contracts that entirely replaced Uber with a non-profit, trustless ridesharing service. Contracts such as these would live beyond the reach of any government and potentially kill off a lot of private industries that are currently defended at the national level by protectionist politicians. The market would be wrestled into something more efficient but less tailored to national interests — a double-edged sword. Some countries will likely prohibit any and all connections to this public blockchain for reasons of security or control. On the plus side, non-profit organizations with smart contracts on the public chain will be able to fund-raise internationally directly from individuals without the need for fee-based currency exchanges or bank intermediaries. Needs can be met near-instantaneously without red tape. States may choose to white-list some public-chain smart contracts and blanket ban the remainder.

• Expect to see a lot of international disputes settled by smart contract. Smart contracts will revolutionize international commitment. Take, for example, the contention that NATO members are not paying 2% of their GDP on their military as required. With a smart contract, this could be guaranteed up-front. “Oh, so you’re saying you’ll commit 2% of your GDP to NATO? Let us see the smart contract that will automatically funnel that tax money to your military for the next two years.” Or how about an automatic punishment for invading a neighbor? All nations could place X% of their annual revenue into a trustless contract, which is burned (lost forever) in the event that a country begins a war of aggression; otherwise the money is returned the next year. Even if a state could replace the burned currency by generating more, it would negatively affect 1) inflation rates, 2) immediate budget outflows, and (potentially) 3) their credit rating. Promises between countries could be trustless and automatic, reducing the pressure to defect from any long-term commitment. “International unity” could be a bunch of peer-reviewed automatic contracts, not just empty words.

• If states opt to make commercial and non-profit information public, organizations could be held more accountable. Imagine easily knowing exactly how much every employee of a company makes, or exactly what percentage of donations go to a non-profit’s administrative overhead rather than services, without the need for auditors. Imagine knowing how your tax dollars (or rubles, or yuan) are spent, directly and without the need for a FOIA request. States are unlikely to make many or most transactions transparent, but under an administration committed to transparency, this is technically possible.

• A new type of institution will emerge — Oracles. Oracles are fantastically important blockchain addresses with truth values reflecting facts about reality that can’t be inferred from other on-chain variables. For example, Oracles will hold answers to questions like “did the US violate a climate treaty,” “which contestant won American Idol,” or “was SpaceX’s launch successful.” Oracles must be completely trustworthy institutions — above reproach — for smart contracts which depend on their values to trigger properly. They must also, largely, live in the public blockchain beyond government manipulation, and they must face the most severe incentives imaginable to stay truthful, as much of the global economy will rely on their values. This is a major vulnerability point for blockchains.

• Bug bounties would become massive. All new code has the potential for unexpected vulnerabilities. With a system as huge and complex as a national chain, financial risk would be enormous. Since all smart contracts are (at this point) necessarily open-source, or at least transparent, massive bug bounties are necessary to incentivize the development community to identify and fix accidental bugs. Sitting on zero-day bugs will not be acceptable.

These possible outcomes are only the most immediately predictable. Blockchains have far-reaching potential, so consequences are difficult to forecast this far in advance. They may result in weirder, more complex effects than we can currently imagine.

In the meantime, there are still technical challenges preventing widespread blockchain deployment — transaction congestion, or price volatility, for example. But possible solutions currently being explored, like sharding and price-stable tokens and sub-tokens, suggest these challenges are surmountable. With praise and backing from both governments and the private sector (like the EEA), along with crowdfunding via ICOs, the fledgling blockchain industry has the political and economic capital to press the weight of thousands of computer scientists against any barriers until the necessary breakthroughs are made.

And there may be multiple solutions to these problems. Blockchains come in many forms, stealing good ideas from one other and experimenting with new feature sets. The current face of tokenization and smart contracts is the Ethereum platform, but whether Ethereum or one of its competitors becomes a global standard does not really matter. In fact, there does not necessarily need to be a global standard, as blockchains can communicate cross-platform. Ethereum can talk to Stratis can talk to Ripple, and so on, in the same way that Macs and PCs communicate via the standard TCP/IP. Countries may find different platforms suitable to their interests, or even (with industry help) develop their own unique platforms.

In sum, blockchains have the potential to entirely reform our conception of economic systems. Even the vocabulary for discussing blockchain-based economies has yet to be formed. There has never needed to be a word for government-hosted economies, because it has never before been possible.

A transition to private national chains would likely be an immensely painful and expensive process. The world has rarely seen a forced mass migration from one economic system to another, especially at this scale and with so many risks to civil liberties. Political resistance may be heavy, and the development process will require coordination between private and public actors across many fields. It almost seems impossible to imagine such a combined and energetic effort, but the economic stresses of a growing and oppositional public blockchain will be acute. Market pressures winnow the unready. Russia and Singapore are the first to publicly (if tentatively) endorse national blockchains, but numbers will grow; what remains is the nature and extent of implementation.