Maduro’s Cryptocurrency Gamble - Does Venezuela’s ‘Petro’ Have a Future?

19.03.2018

Cryptocurrencies and blockchain ledgers were first developed by the cypherpunk community as a way to offer decentralized, anonymous, and trust-less financial transactions to enhance personal privacy and inspire social change. The powerful technology that emerged from these efforts has grown quite a bit over the last decade, going well beyond anything that Satoshi Nakamoto could have imagined.

Now a new cryptocurrency project represents one of the last hopes for a government and economy in critical decline.  

Many new startups have been able to circumvent traditional financial markets with an initial coin offering (ICO) to finance their operations, but one of the newest ICOs comes from a rather unlikely new source also looking to bypass traditional markets.

Venezuelan President Nicolas Maduro oversaw the pre-sale launch of the state-sponsored and oil-backed cryptocurrency project called the Petro on February 20. Maduro and his government are hoping that the new Petro will help the South American country circumvent Western financial sanctions and bring in much needed foreign capital to stimulate Venezuela’s nosediving economy.

Just a week after the pre-sale, Maduro announced that the Petro had already gathered $3 billion from 171,015 certified purchases coming from 127 countries.

In fact, Chinese investment rating agency Dagong announced that the Petro has the potential to “correct” existing “imbalances” in the global financial order.

We aim to outline what the Petro is, where it came from, and what we believe to be the biggest upside and downside factors underpinning this new state-sponsored and resource-backed cryptocurrency.

Financial Crisis

Maduro is currently presiding over Venezuela’s worst economic crisis in decades. The bolivar, Venezuela's official currency, is close to worthless. Inflation skyrocketed in 2017, sending the unofficial value of the currency shooting from 3,200 bolivars per dollar at the beginning of 2017 to over 220,000 bolivars per dollar in February 2018, an inflation rate of over 7,000%. The official rate remains 10 bolivars to the dollar, but this rate is inaccessible for average citizens, who are forced to acquire foreign currency through the black market.

Many goods from abroad are simply no longer found on bare supermarket shelves. Stacks of bolivars are required to purchase basic commodities like flour and milk.

Venezuela’s worsening political and economic crisis is causing citizens to flee the country in droves. Colombia received around 550.000 people from Venezuela in 2017, a number which could double by July 2018 according to official statistics.

Sanctions

President Maduro has pointed to Western sanctions as the leading cause of the South American country’s economic problems, saying that the Venezuelan government is the victim of an “economic war.”

The United States announced financial sector sanctions against Venezuela on August 25, 2017, targeting Venezuelan government bonds and debt offered by Petroleos de Venezuela S.A. (PDVSA), the state oil company. On the US State Department website, the stated goal of the the Venezuelan sanctions is to “deny the Maduro regime a critical source of financing with which it maintains its rule” and to “restrict the Venezuelan government from using the U.S. system to restructure existing debts,”

Venezuela, a member of the Organization of the Petroleum Exporting Countries (OPEC), sits on 297 billion barrels of proven oil reserves, the largest in the world. Sales of oil account for 95 percent of export earnings and the oil and gas sector makes up about 25 percent of the Venezuelan economy.

The sanctions shut Venezuela’s most important sectors out of the dollar market, leaving it unable to roll over its existing dollar-denominated debt. In order to avoid defaulting on its debt and making its situation even worse, Venezuela was forced to use foreign currency earned by selling oil to pay bondholders instead of using its dollars to buy food and medicine from abroad, as it had done in the past.

Enter the Petro

Maduro announced on state television in early December 2017 that Venezuela would be rolling out its own cryptocurrency. In his announcement, Maduro said that the Petro was intended as a way to bypass Western sanctions and raise foreign capital vital to Venezuela’s ailing economy. Investors who bought into Venezuela’s token sale would not technically be buying into government bonds or PDVSA debt, so they would be out of the purview of the existing sanctions.

Venezuela’s opposition reacted to the announcement largely negatively. Opposition lawmaker Jorge Millan said that the Petro project was an illegal “forward sale” of Venezuela’s oil and that it was “tailor made for corruption” in comments made during a televised parliamentary sitting on January 11. The US Treasury Department issued a warning on January 16, saying that investment into the Petro cryptocurrency may actually violate US sanctions.

Despite some of the negative feedback, Maduro and his government proceeded with developing the Petro.

Technical Specs

The Petro is a national Venezuelan cryptocurrency purportedly tied to the global price of oil in dollars. Maduro announced that 100 million units of Petro will be created and that each unit of Petro will be worth about $60, meaning that Venezuela aim to raise about $6 billion through the cryptocurrency project.

Initially, the Petro white paper claimed that the cryptocurrency would be built on the Ethereum blockchain as an ERC20 token, but a manual made public on February 20 revealed that it would actually be based on the NEM blockchain. Maduro has also said that he was working with a Singapore-based cryptocurrency exchange called Zeus for help with other technical matters.

Mining centers for servicing Petro transactions have been set up in universities across the country. Maduro announced through several tweets published on February 20 that the Petro would be accepted by national tourism operators, the national airline, gas stations, and consular services. The Petro will also be made available to the 15 million or so Venezuelan citizens who possess a national ID card and may be incorporated into a future national payment system.

A Petro buyer’s manual released by the Venezuelan government describes the steps needed to set up a Petro wallet and purchase some of the cryptocurrency, but also contains a warning about wallet security. Buyers will only be able to purchase Petros with top fiat and cryptocurrencies, while exchange of Petros for bolivars will not be possible yet.

Petro Pre-Sale

The pre-sale for Petro tokens was launched by President Maduro on February 20. 82.4 million units of Petro were offered to investors in the pre-sale, for a total of $4.94 billion at a rate of $60 per unit. Venezuelan Cryptocurrency Superintendent Carlos Vargas said the government was expecting to draw investment from investors in Turkey, Qatar, the United States and some unnamed European countries. A Reuters report cited some unnamed Venezuelan advisors which suggested that the government offer 38.4 percent of the Petro units at a 60 percent discount.

Without naming any names, Maduro announced that the Petro pre-sale raised $735 million on February 21, the day after the pre-sale was launched. The amount of Petros sold and the rate at which they were sold has not been revealed.

Maduro’s Gamble

President Maduro and Venezuelan government are racing against the clock to fix the current hyperinflationary spiral, which is expected to reach 13,000 percent by the end of 2018. Presidential elections were scheduled for December 2018, but the country’s Constituent National Assembly have called for snap elections to be held on April 22, 2018.

If the Petro proves successful in raising money for the state, Maduro has announced plans to experiment with other cryptocurrency projects aimed at helping the government avoid sanctions and raise money by backing the cryptocurrencies with valuable natural resources, like gold and diamonds.

Venezuela’s state-sponsored and oil-backed cryptocurrency, the first in the world, will provide the South American country with plenty of experience working with blockchain technologies. Potentially, the Petro project could provide the infrastructure for attracting cryptocurrency entrepreneurs and investment.

Further, transforming Venezuela’s economy to enable payments with cryptocurrency may not only encourage businesses to experiment with accepting different types of cryptocurrencies and inspire a wave of innovation, it could be the answer to Venezuela’s currency crisis. If the government is able to successfully implement a national payment system underpinned by the Petro, they may be able to encourage citizens to trade in their fiat currency for Petro and finally work to stop the bolivar’s drift toward worthlessness.

Potential Upsides

The Petro ICO is an unprecedented and ambitious project with plenty of upside potential. Here are the biggest potential boons:

1. Backed by Tangible Goods

Although Maduro and company don’t quite explain how the Petro for oil exchange mechanism is going to work, the president has pledged Venezuela’s oil reserves as collateral to holders of the Petro. At least in theory, Petro owners will be able to send one unit of Petro to Venezuela and receive one barrel of Venezuelan oil in return. How this will play out in practice leaves many scratching their heads, but if an effective exchange arrangement emerges, Maduro can expect to see success with a gold and diamond-backed cryptocurrency as well.

2. Adoption and Acceptance by Businesses

Maduro’s announcement that some businesses will accept Petro (whether they want to or not) may be one of the most significant factors that contribute to the Petro’s long-term success. Adoption of the Petro by the common people and a high daily volume of Petro transactions, if they were ever to actually happen, would cement the Petro firmly in Venezuela’s future.

However, it is unclear whether the NEM blockchain platform will be able to produce fast enough transaction times to be practically useful as a national payment system. Transfer of tokens on the NEM blockchain from Nano Wallet to Nano Wallet typically takes under a minute, but that is still ages longer than VISA or Mastercard. The ability of Venezuela’s communications infrastructure to support cryptocurrency transactions for everyday purchases is also under doubt. Forcing citizens to transact via cryptocurrency may be a good idea, but it is far from clear whether the blockchain itself or the technical infrastructure will be able to handle a large volume of daily transactions efficiently.

3. Government Support

The government’s commitment to provide technical infrastructure, support, programmers, and other services has no doubt taken a small toll on their pocketbook, but these are expenses that many young blockchain companies simply could never afford. The government also has access to state-sponsored TV, a powerful PR tool that would bring the Petro into millions of Venezuelan homes and potentially increase adoption rates among the domestic population.

Potential Land Mines

Although there are some potential green shoots for the Petro, there are also plenty of risks which could scuttle the project or leave investors disappointed. Here are the biggest:

1. Super Centralized

One of the oddest quirks about the state-sponsored Petro is that the integrity of transactions and ledgers will be guaranteed by the government. A small group of people in Venezuela’s government will have control over factors of price and emission. It is no stretch of the imagination to suggest that these people, some of whom will certainly be large holders of Petro, will be tempted to influence the Petro’s valuation by artificial means. Venezuela’s already shaky financial reputation taken into account, one case of fudging the books or somebody skimming some Petros for himself may be all it takes to bring down the house of cards.

Further, Maduro announced that only 8 cryptocurrency exchanges throughout Venezuela will have the right to handle purchase and sale of Petro. These exchanges must be licensed by the government and must follow certain government regulations in order to maintain their licenses. The government could simply mandate that the exchanges not give out any foreign currency for Petros, for example.

2. Huge Political Risks

Venezuela’s political elite may not be around for a second term and may not even be around by summer. If Maduro and his government do not remain in power, it’s unclear whether or not the new leaders would continue Maduro’s Petro project. If a new government goes decide to abandon the Petro, that may leave investors holding the bag.

However, even if Maduro and his government do manage to stick around, there is no guarantee that they won’t simply default on their obligations to Petro investors. Investors who purchase Petro don’t appear to have any guarantees that they will be able to exercise their ‘right’ to exchange their Petros for oil, should that become necessary.

3. Finite Token Growth

Several investors have mentioned that Maduro’s Petro project has a price ceiling. Maduro announced that only 100 million units of Petro would ever be created and made it very clear that the price of a unit of Petro would be strongly correlated to the price of oil. He could always change his mind and make more Petros, but one thing he can’t change is the amount of oil under Venezuela’s ground. The strong correlation with the dollar price of oil may curb investor appetite for Petros because investors that want to speculate on the oil price can buy futures through Wall Street much more securely. Maduro’s proposal of a different cryptocurrency backed by other national resources, like gold or diamonds, may help mitigate this problem.

However, if the Petro becomes interlinked with the national payment system, that fact alone could deliver strong growth potential for the token price. Technical questions about transaction speed remain.

Key Takeaways

Regardless of whether or not the Petro succeeds as a cryptocurrency, the entire episode features some underlying trends which are indicative of bigger changes to the world of cryptocurrency.

1. State-Sponsored Cryptocurrencies

Many people and governments will be watching not only the initial coin offering of Venezuela’s Petro, but also the implementation of the cryptocurrency on the national level. Venezuela’s push to launch the Petro will certainly set a precedent, potentially inspiring countless copycats or encouraging others to put their own state-backed cryptocurrency plans on the backburner.

Creating and releasing a state-sponsored cryptocurrency may be an optimal solution for countries with a wealth of natural resources but also experiencing currency problems. Just like ICOs for startups, an offering of a state-backed cryptocurrency is an excellent way to seek funding outside of institutional investors. State-backed cryptocurrency offerings don’t simply offer a way around financial sanctions, they also enable the government to diversify their pool of investors and become less dependent on established players. Iran has announced that they are also considering releasing their own state-backed cryptocurrency, among others.

2. Everyday Transactions in Cryptocurrencies

Although small, localized efforts to accept cryptocurrency as payment for common goods have been attempted in places like Japan and the US, Venezuela’s Petro will be the first national-level attempt to incorporate cryptocurrency into the mix of national payment methods. The Petro will undoubtedly face numerous challenges and obstacles, not the least of which are technical as mentioned earlier. However, any amount of success in Venezuela will certainly encourage other countries and companies to experiment with wider adoption of cryptocurrency payments.

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