Russia is on the hunt to find an alternative to the dollar to settle international trade deals and on September 1 will test making cross-border payments in cryptocurrency for the first time.

Initially wary of cryptocurrencies, the government has rushed through a raft of legislation to underpin electronic money. The Central Bank of Russia (CBR) has been running digital ruble pilot projects for a limited number of customers over the last two years, which should be fully launched in 2025, and crypto mining and payments were legalised in August, among other measures.

Following the imposition of the SWIFT sanctions only days after Russia’s invasion of Ukraine that cut Russia off from using the dollar, the Kremlin has tried to switch to the switch to the yuan to settle trade deals, but the introduction of the US so-called strangulation sanctions has made even that increasingly difficult.

This year Russian companies are finding it much more difficult to make cross-border payments in yuan as their Chinese counterparties refuse to accept their “dirty yuan” for fear of bringing down US secondary sanctions on themselves. Currently, about 80% of payments in yuan are returned back to Russia, according to Kommersant. Clients have to resort to the services of a string of smaller intermediaries which has sent the cost of settlement soaring. The CBR is hoping to solve this problem with digital financial assets (DFA) instead of cash.

In the meantime, yuan liquidity in the Russian system is running short. The Shanghai branch of VTB Bank is reportedly running low on yuan and has been actively courting Russian exporters to China to increase its supply of yuan. The amount of yuan liquidity in the Russian banking system is also low, according to the CBR.

In June and July the government twice lowered the threshold for mandatory foreign currency earnings surrender requirement to try and improve FX liquidity: first from 80% to 60%, and then to 40%, Vedomosti reports.

Going digital

Digital currency settlements of trade only became possible after a new law was signed in early August, which permits the experimental use of digital currencies in cross-border transactions under the CBR’s supervision. This marks a significant shift in mentality as the regulator has traditionally been wary about integrating cryptocurrency into the financial system.

The groundwork for this experiment began in late 2022, when Prime Minister Mikhail Mishustin tasked various government bodies, including the Ministry of Finance and the Central Bank, with developing a mechanism for using cryptocurrency in international settlements. According to CBR Governor Elvira Nabiullina, the first cryptocurrency payments are expected before the end of the year.

Exporters and importers in Russia have reported that while transaction fees for such payments have decreased – from around 7% to about 1% – the need for alternative payment methods remains critical as the strangulation sanctions continue to tighten, reports Vedomosti.

The law introduces special experimental legal regimes in various sectors, including the financial market, allowing for exemptions from certain federal laws, which previously restricted the use of cryptocurrencies. Within this framework, the Central Bank will be authorised to create an electronic platform for digital currency operations, regulate organised trades of cryptocurrencies, and set rules for the use of digital currencies in foreign trade.

Experts are cautiously optimistic. Many see the use of cryptocurrency as a means to circumvent SWIFT restrictions and Russia’s own alternative payment system, the Financial Communications System (SPFS), which works, but has not been a big success.

Experts told Vedomosti that using cryptocurrency for foreign trade is not only feasible but necessary in the current geopolitical climate. But they say that more work needs to be done to the legal framework and the integration of blockchain into the national payment system are key to scaling cryptocurrency settlements in foreign economic activities.

The main hurdle to the scheme will be convincing foreign partners to accept cryptocurrency payments, as many will still fear falling foul of the US secondary sanctions.

While this initiative may not immediately replace traditional banking networks, it represents a significant step toward developing an alternative payments system that could position Russia as a leader in the cryptocurrency-based cross-border payments market, particularly in countries facing similar political and economic pressures. In general, emerging markets in particular are keen to de-dollarise trade after the US shocked central bankers worldwide by weaponizing the dollar in its clash with Russia. The use of the dollar to settle international trade has fallen from some 85% of all deals pre-war to 48% now and the share of the dollar in global sovereign international reserves has also fallen noticeably in the last two years.

e-BRICS

One of the topics of the agenda for the upcoming BRICS summit to be held in Kazan in Russia this autumn is developing and adopting a BRICS blockchain-based payment system by creating a common currency to de-dollarize the global economic system by introducing a new currency.

The new BRICS Pay system has been attracting not only BRICS countries but also other nations interested in an alternative to the dollar, and perhaps less regulated, payment system that is not controlled and tracked by the US and its allies.

To survive Western sanctions and undermine the US dollar's dominance globally, the new payment system will be integrated with digital versions of the ruble, yuan, rupee and other currencies, but the earliest the new system will appear is 2028, according to reports.

In the meantime, countries like Russia and China and other friendly countries are increasingly switching to settling trade in their mutual national currencies. The ruble overtook the yuan to become the main currency used for settling international trade deals, the CBR reported on April 8.

The ruble accounted for a record 42.9% of payments for Russian imports in June, marking its fifth consecutive month of strengthening, according to an analysis by RIA Novosti based on data from the Central Bank. This achievement was supported by new historical highs in transactions for goods from Africa, at 54.1%, and from Europe, at 58.7%. In terms of exports, the ruble increased its share by 5.8 percentage points, reaching 43%, approaching the record levels seen in March.

The lack of dollars has been a particular problem for Russo-Indian trade, where Russia runs a whopping circa $40bn trade surplus with India due to its booming oil exports, building up a huge pile of rupees as a result as India produces little of anything that Russia wants to buy. Moreover, the rupee is only partially convertible and consequently subject to US sanctions. Russia’s trade with China, by comparison, is relatively well balanced, making settlements in national currencies very convenient.

The partners have found a way around this problem as Russia has been covertly sourcing sensitive electronics from India to support its war in Ukraine, Financial Times reported on September 4. According to the report the Russian Ministry of Industry and Trade, which manages military production since the outbreak of the war in Ukraine, outlined plans in October 2022 to spend INR82bn ($1bn) to secure vital components through ‘grey area’ supply chains across the world, in the process bypassing Western sanctions.

Moscow sought to tap into the substantial rupee reserves accumulated from Indian oil sales, targeting India as an alternative market for dual-use technology – goods with both civilian and military applications. The Kremlin considered India a source for components that Russia previously obtained from "unfriendly countries."

Documents referenced by the FT suggest Moscow explored setting up joint Russo-Indian production facilities. However this likely didn’t fit the risk calculus of the local authorities and was almost certainly deemed too risky by any Indian authorities involved.

India’s role as a supplier to Russia and its state entities, despite its close ties to the US, has subsequently raised concerns in Washington that may impose sanctions on India if the report is confirmed.

Mining race

The United States and Russia lead global cryptocurrency mining, with the US commanding 30% of the world’s hash rate and Russia at 16.25%. However, the competition for global dominance in cryptocurrency mining entered a new phase in August when Russia made significant strides to challenge the United States. On August 8, as part of the package of crypto legislation being developed, Putin signed a law aimed at boosting the country's crypto mining sector, designed to overtake the US as the rivalry heats up.

That same month, leaders from 50 American mining companies issued an open letter to President Joe Biden and Democratic candidate Kamala Harris, calling for regulatory clarity in the industry. Senate Majority Leader Chuck Schumer emphasised the importance of bipartisan cooperation to ensure the United States remains a global leader in innovation as part of the US’ wider policy of remaining the global technology leader.

While Russia is the world’s number two biggest crypto miner, it is the world’s number one in terms of rate of growth of its mining capacity. The adoption of the August law on mining will accelerate the growth rate, as well as increasing production volumes by 20-40% annually consuming 5-6 GW of power cheap Russian power in three years’ time, according to the Kremlin.