## Elements of Effective Policies for Crypto Assets (ppea2023004) ## Source details **Canonical URL:** [Elements of Effective Policies for Crypto Assets (ppea2023004)](https://www.imf.org/-/media/files/publications/pp/2023/english/ppea2023004.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2023/english/ppea2023004.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2023/english/ppea2023004.pdf.json) --- ### Executive Summary — key messages - Crypto assets have grown from niche products to wider adoption, with volatile market capitalization and increased interconnectedness with the financial sector. - Failures in the crypto ecosystem (examples cited: FTX, Terra USD) and a nearly $2 trillion decline in crypto asset value during spring/early summer of 2022 intensified the need for effective policies. - Purported benefits (cheaper/faster cross-border payments, increased financial inclusion, greater portfolio diversification, greater operational resilience, increased transparency/traceability) largely have not yet materialized; underlying technological innovations may prove useful longer term. - Major risks include: - Macroeconomic risks: risks to monetary policy effectiveness, capital flow volatility, fiscal risks. - Financial risks: financial stability, financial integrity, legal risks, consumer protection, market integrity, and contestability. - Some risks stem from technology; others from lack of policies or enforcement, including offshore location of service providers marketing globally. - Nine core elements of an effective policy framework are proposed (see "Nine core elements of an effective crypto policy framework (explicit)"). ### Nine core elements of an effective crypto policy framework (explicit) - 1. Safeguard monetary sovereignty and stability by strengthening monetary policy frameworks and do not grant crypto assets official currency or legal tender status. - 2. Guard against excessive capital flow volatility and maintain effectiveness of capital flow management measures. - 3. Analyze and disclose fiscal risks and adopt unambiguous tax treatment of crypto assets. - 4. Establish legal certainty of crypto assets and address legal risks. - 5. Develop and enforce prudential, conduct, and oversight requirements to all crypto market actors. - 6. Establish a joint monitoring framework across different domestic agencies and authorities. - 7. Establish international collaborative arrangements to enhance supervision and enforcement of crypto asset regulations. - 8. Monitor the impact of crypto assets on the stability of the international monetary system. - 9. Strengthen global cooperation to develop digital infrastructures and alternative solutions for cross-border payments and finance. ### Executive Board Assessment — salient points from Directors - Directors welcomed timeliness and relevance; emphasized need for a comprehensive framework due to growing adoption, extra-territorial nature, and interlinkages with the financial system. - Agreed points: - Robust macroeconomic policies, credible institutions, and monetary policy frameworks are first-order requirements. - Crypto assets should not be granted official currency or legal tender status to safeguard monetary sovereignty and stability. - Fiscal risks, including contingent liabilities, should be fully disclosed in fiscal risk statements; tax treatment applicability should be clarified. - Comprehensive regulation is needed, including prudential and conduct regulation, and effective implementation of FATF standards on AML/CFT. - Fund should work closely with and align to standard-setting bodies; framework should be aligned with initiatives and standards set by standard-setters. - Strict bans are not first-best; targeted restrictions could apply depending on domestic objectives and capacity constraints; a few Directors thought outright bans should not be ruled out. - Regulation should avoid stifling innovation; public sector may leverage underlying technologies for public policy objectives. - Implementation priorities and sequencing: - Prioritize elements where countries face implementation challenges (including weak regulatory institutions). - Pace and sequencing should be tailored to country circumstances. - Underpin regulatory treatment with clear private and public law frameworks. - Strong domestic and international coordination is critical to avoid regulatory arbitrage. - Promote “same activity, same risk, same regulation.” - Fund role and capacity development: - Guide staff policy dialogue, capacity development, and participation in standard-setting discussions. - Focus on the Fund’s comparative advantage and macrofinancial implications. - Serve as a bridge between membership experience and international standard-setting; disseminate best practices. - Provide tailored advice and close dialogue with authorities; Fund capacity development support will be crucial. - Data and monitoring: - Address significant data gaps; Fund to monitor risks and impacts on the international monetary system. - Welcomed the new G20 Data Gaps Initiative. - Ensure consistent recording of crypto assets in macroeconomic statistics across economies. ### Policy and regulatory responses — principal recommendations and emphasis - Monetary policy and legal tender: - Strengthen monetary policy frameworks to safeguard monetary sovereignty and stability. - Do not grant crypto assets official currency or legal tender status. - Capital flows and macroprudential: - Guard against excessive capital flow volatility; maintain effectiveness of capital flow management measures. - Fiscal and tax treatment: - Analyze and disclose fiscal risks related to crypto assets; include contingent liabilities in fiscal risk statements. - Adopt unambiguous tax treatment of crypto assets. - Legal certainty and enforcement: - Establish legal certainty for crypto assets and address legal risks. - Develop and enforce prudential, conduct, and oversight requirements for all crypto market actors. - Institutional coordination: - Establish joint monitoring frameworks across domestic agencies and authorities. - Establish international collaborative arrangements to enhance supervision and enforcement of crypto asset regulations. - International monetary system and payments infrastructure: - Monitor the impact of crypto assets on the stability of the international monetary system. - Strengthen global cooperation to develop digital infrastructures and alternative solutions for cross-border payments and finance. - Regulatory approach and sequencing: - Favor comprehensive regulations aligned with standard-setters; avoid piecemeal or fragmented approaches. - Targeted restrictions may be appropriate where domestic objectives or capacity constraints warrant them; strict bans are not the default. - Ensure sequencing and pacing of implementation are tailored to country capacity and circumstances. - Data, monitoring, and capacity building: - Address data gaps; ensure consistent recording of crypto assets in macroeconomic statistics. - Provide country-specific capacity development and prioritize countries with implementation challenges. ### Definitions, taxonomy, and ecosystem characteristics - Broad definition: Crypto assets are privately issued digital representations of value that are cryptographically secured and deployed using distributed ledger technology. - Categories highlighted: - Unbacked tokens: - No backing assets; usually decentralized; transferable; no redemption pledge; provide no direct claims on the issuer. - With no backing assets, unbacked tokens have volatile prices and are generally not well suited to perform main monetary functions. - Example cited: Bitcoin. - Stablecoins: - Centrally or decentrally issued; aim to have a stable price through reserves or algorithms. - Generally denominated in a monetary unit of account and may pledge to redeem into cash at par. - Range of reserve quality and legal claim features across arrangements. - Example cited: USDC. - Other tokens: - Utility tokens and security tokens; vary by transferability, issuance, and applicable securities laws. ### Purported benefits — detailed findings and numeric evidence - Cheaper and faster payments potential: - DLT can reduce intermediaries, but validators and other intermediaries (exchanges, custodial wallet providers) impose costs. - Box 2 transaction cost findings: - Median Bitcoin network transaction fee over the last three years was $2.72 (Statista). - Median value of Bitcoin transactions is presently $93.61 (CoinDesk), implying a median transaction fee of 2.9 percent (Kaloudis and Young 2022). - Average fee for a $200 remittance was 5.7 percent in 2020, with the 75th and 25th fee percentiles equal to 7.7 and 4 percent, respectively (Beck, Janfils, and Kpodar 2022). - Fee comparisons and examples: - CoinBase, Binance, Kucoin, and Bitfinex do not charge fees for intra-exchange retail transfers. - CoinBase Commerce charges a 1 percent payment processing fee to merchants. - Credit cards typically charge merchants an interchange fee of between 1 to 3 percent. - Innovation: - Open, programmable, and composable DLT architectures can spur private sector innovation and diffusion of knowledge. - Operational resilience: - Multiple copies of ledgers and validating nodes may provide higher operational resilience compared to centralized entities; trade-off with transaction validation speed (the "blockchain trilemma"). - Transparency and traceability: - Public DLTs allow blockchain analytics and regtech/suptech tools to identify illicit transactions, though geo-blockers, off-chain transactions, and privacy-enhancing mechanisms pose challenges. - Financial inclusion potential: - DLT could improve access for unbanked populations and lower cross-border costs in some corridors, but high cash-in/cash-out costs, digital literacy, and internet connectivity constrain potential. ### Macroeconomic risks and "cryptoization" - Transmission of monetary policy could weaken if agents prefer crypto assets not pegged to domestic fiat currency (IMF 2020). - Cryptoization risk is particularly pertinent for countries with unstable currencies and weak monetary frameworks. - Stablecoins denominated in foreign currencies increase cryptoization probability. - Crypto assets may erode effectiveness of capital flow measures: - Crypto trades may bypass intermediaries subject to CFMs; pseudonymity complicates enforcement. - Possible policy responses: - Clarify legal status of crypto assets. - Ensure CFMs cover crypto assets and actors, ideally also abroad. - Address data gaps and develop anomaly detection models and red-flag indicators. - Greater exchange rate flexibility may be required; recalibration of international reserves could be necessary. ### Financial stability, legal, consumer protection, and market integrity risks - Financial stability: - Sharp declines in crypto prices can negatively affect investor balance sheets and the financial sector. - Direct and indirect exposures through trading, custody, lending, and collateral use can create spillovers. - Governance tokens and open architectures raise governance and cyber/operational risks. - Estimate cited: share of Bitcoin lost in wallets at 17-23 percent of all mined Bitcoin. - Legal risks: - Uncertainties in private and financial law classification can affect ownership, recovery in insolvency, and supervisory mandates. - Cross-border differences increase conflict-of-law challenges and regulatory arbitrage. - Consumer protection: - Risks arise from inadequate governance, opaque decision-making, price volatility, fraud, and cyber-attacks. - FTX bankruptcy (filed for bankruptcy protection on November 11, 2022) and TerraUSD (May 2022) highlighted severe consumer protection and systemic concerns. - Market integrity and contestability: - Manipulation and fraud risks: permissionless DLT users can set transaction fees to affect settlement queues; large validators could congest blockchains with artificial trades. - Probabilistic settlement in many consensus mechanisms introduces settlement finality issues (possibility of forks). - Energy/environmental impact: proof-of-work is highly energy intensive and generates e-waste; other consensus mechanisms may be more energy efficient. ### Regulatory design, entity-level rules, and stablecoins - Comprehensive regulation preferred to blanket bans to address externalities and internalities; blanket bans may: - Stifle innovation, drive illicit activities underground, and be costly to enforce. - Targeted restrictions or temporary bans may be justified for: - Large capital outflows, significant currency substitution, unacceptable ML/TF risk, or consumer/market risks. - Entity- and system-level rules: - Crypto asset service providers should be licensed, registered, or authorized. - Entities offering multiple core functions should be regulated based on risks across activities; conflicts of interest must be addressed. - If designated systemic, providers should be subject to additional oversight and PFMI when performing payment functions. - Stablecoin-specific guidance: - Focus on reserve assets, capital, issuance/redemption/stabilizing mechanisms, transfer function, and access. - Governance, third-party audits of reserves, and mandatory proof-of-reserve practices recommended. - Where systemically important, apply requirements comparable to systemically important banks, tailored to business models. ### AML/CFT, DeFi, and P2P transaction challenges - Implement FATF standards on virtual assets (VAs) and virtual asset service providers (VASPs); ensure laws cover VAs and authorities have powers to freeze, seize, and confiscate VAs. - Monitor and mitigate ML/TF risks in DeFi and P2P contexts where intermediaries may be absent. - Possible measures include enhanced AML/CFT measures for intermediaries dealing with unhosted wallets and identifying DeFi intermediaries that can be regulated. - Digital ID, blockchain-based regtech and suptech can improve AML/CFT effectiveness but have limitations (off-chain transactions; anonymity-enhancing features). ### Data, monitoring, and international coordination - Key data points and recommendations: - Significant data gaps hinder risk assessment; develop a statistical methodology and data collection framework for consistent recording in macroeconomic statistics. - The new G20 Data Gaps Initiative includes a recommendation for development of a data collection framework for crypto assets. - Authorities should collaborate on data collection, work with blockchain analytics firms, and share data across home and host authorities. - International cooperation: - Cross-border nature of providers requires international collaboration, information sharing, and adapted supervisory and enforcement arrangements. - Existing cooperation protocols (bilateral MoUs, multilateral MoUs, supervisory colleges) should be expanded to cover the crypto ecosystem. - Consider mechanisms to authorize and regulate foreign-domiciled providers offering services domestically. ### Implementation challenges, sequencing, and pragmatic approaches - Key constraints: - Resource and expertise shortages. - Lack of comprehensive and comparable data. - Fragmented implementation and taxonomy differences enabling regulatory arbitrage. - Pragmatic approach: - Pursue a "constrained best solution": national frameworks guided by global standards, supplemented by targeted restrictions where capacity is lacking. - Prioritize establishing legal certainty within private and public law, then implement comprehensive and consistent regulations; targeted restrictions may be interim measures. - Use public communication, innovation hubs, and regulatory sandboxes to improve understanding and fill gaps. ### Standards, guidance, and examples - Basel Committee on Banking Supervision (BCBS): - Finalized prudential standard in December 2022 with implementation agreed by January 1, 2025. - Proposal split crypto assets into lower-risk anchored crypto assets and higher-risk “traditional” crypto assets; conservative prudential treatment for traditional crypto assets including a 1250 percent risk weight for maximum long and short positions. - CPMI and IOSCO: - 2022 guidance on applying PFMI to stablecoin arrangements; further work on multicurrency SAs and non-cash reserve assets expected. - FATF: - Defined virtual assets and VASPs in 2018; Standards and updated guidance apply to VAs and VASPs. - FSB: - October 2020 recommendations on global stablecoin arrangements; February 2022 assessment concluded crypto assets are not globally systemic but stablecoins may become systemic. - IOSCO: - February 2020 report on exchanges; 2022 fact-finding on DeFi. ### FTX case study — facts, impacts, and policy implications - Key facts and market impact: - FTX was once valued at $32 billion. - FTX filed for bankruptcy protection on November 11, 2022. - Price impacts: Bitcoin dropped 23 percent; Ether dropped 43 percent. - DeFi total value locked (TVL) dropped by around 17 percent to 45 billion. - Vulnerabilities and recommended responses: - Lack of basic information on exchanges (corporate structure, financial information, composition of reserves) hampers assessment. - Opaque intra-group transactions (FTX reportedly lent more than half of its customer funds to Alameda Research; Alameda held significant claims on FTX via FTT) highlight governance and risk management failures. - Policy responses: strengthen governance and risk management; ensure segregation of customer assets; impose clear regulatory requirements where trading, storage, and brokerage are integrated; increase transparency and third-party audits. ### Conclusion highlights - The paper proposes nine elements along three dimensions to inform a comprehensive, consistent, and coordinated policy framework: - Dimension 1 (macro-financial): monetary, capital flow management, and fiscal aspects; do not declare privately issued crypto assets as national currency. - Dimension 2 (domestic regulation, supervision, oversight): legal certainty, comprehensive regulations, prudential and conduct requirements. - Dimension 3 (global coordination and technology for public policy): global coordination, monitoring impacts on the international monetary system, and developing alternatives for cross-border payments. - The public sector can catalyze development of digital infrastructures and consider issuance of central bank digital currency while managing complex policy and technical issues. *Source: Elements of Effective Policies for Crypto Assets, International Monetary Fund, January 4, 2023.* ### 1. Safeguard monetary sovereignty and stability by strengthening monetary policy ### 1. Safeguard monetary sovereignty and stability by strengthening monetary policy frameworks and do not grant crypto assets official currency or legal tender status ### Executive Summary — key messages - Crypto assets have grown from niche products to wider adoption, with volatile market capitalization and increased interconnectedness with the financial sector. - Failures in the crypto ecosystem (examples cited: FTX, Terra USD) and a nearly $2 trillion decline in crypto asset value during spring/early summer of 2022 intensified the need for effective policies. - Purported benefits (cheaper/faster cross-border payments, increased financial inclusion, greater portfolio diversification, greater operational resilience, increased transparency/traceability) largely have not yet materialized; underlying technological innovations may prove useful longer term. - Major risks include: - Macroeconomic risks: risks to monetary policy effectiveness, capital flow volatility, fiscal risks. - Financial risks: financial stability, financial integrity, legal risks, consumer protection, market integrity, and contestability. - Some risks stem from technology; others from lack of policies or enforcement, including offshore location of service providers marketing globally. - Nine core elements of an effective policy framework are proposed (listed below). ### Nine core elements of an effective crypto policy framework (explicit) - 1. Safeguard monetary sovereignty and stability by strengthening monetary policy frameworks and do not grant crypto assets official currency or legal tender status. - 2. Guard against excessive capital flow volatility and maintain effectiveness of capital flow management measures. - 3. Analyze and disclose fiscal risks and adopt unambiguous tax treatment of crypto assets. - 4. Establish legal certainty of crypto assets and address legal risks. - 5. Develop and enforce prudential, conduct, and oversight requirements to all crypto market actors. - 6. Establish a joint monitoring framework across different domestic agencies and authorities. - 7. Establish international collaborative arrangements to enhance supervision and enforcement of crypto asset regulations. - 8. Monitor the impact of crypto assets on the stability of the international monetary system. - 9. Strengthen global cooperation to develop digital infrastructures and alternative solutions for cross-border payments and finance. ### Executive Board Assessment — salient points from Directors - Directors welcomed the paper’s timeliness and relevance across the IMF’s membership and underscored the need for a comprehensive framework. - Growing adoption, extra-territorial nature of crypto assets/providers, and increasing interlinkages with the financial system motivate a comprehensive, consistent, coordinated response. - Directors observed that supposed benefits have yet to materialize while significant risks have emerged, including macroeconomic, financial stability, financial integrity, legal, consumer protection, and market integrity risks. - Directors agreed: - Robust macroeconomic policies, credible institutions, and monetary policy frameworks are first-order requirements. - Crypto assets should not be granted official currency or legal tender status to safeguard monetary sovereignty and stability. - Fiscal risks, including contingent liabilities to the government, should be fully disclosed in countries’ fiscal risk statements; tax treatment applicability should be clarified. - Comprehensive regulation is needed, including prudential and conduct regulation, and effective implementation of FATF standards on AML/CFT. - The Fund should work closely with and align to standard-setting bodies; the framework should be fully aligned with initiatives and standards set by standard-setters. - Strict bans are not first-best, but targeted restrictions could apply depending on domestic objectives and capacity constraints; a few Directors thought outright bans should not be ruled out. - Regulation should avoid stifling innovation; public sector may leverage underlying technologies for public policy objectives. - Implementation priorities and sequencing: - Prioritize elements where countries face implementation challenges (including weak regulatory institutions). - Pace and sequencing should be tailored to country circumstances. - Underpin regulatory treatment with clear private and public law frameworks. - Strong domestic and international coordination is critical to avoid regulatory arbitrage. - Promote “same activity, same risk, same regulation.” - Fund role and capacity development: - Framework should guide staff policy dialogue, capacity development, and participation in standard-setting discussions. - Focus on the Fund’s comparative advantage and macrofinancial implications. - Fund to serve as a bridge between membership experience and international standard-setting; disseminate best practices. - Tailored advice and close dialogue with authorities are essential given heterogeneity across members. - Fund capacity development support will be crucial. - Data and monitoring: - Directors stressed addressing significant data gaps; Fund role in monitoring risks and impacts on the international monetary system. - They welcomed the new G20 Data Gaps Initiative. - Consistent recording of crypto assets in macroeconomic statistics across economies, underpinned by a reliable data framework, is important. - Forward-looking: - Fund could serve as a thought leader for further analytical work on rapidly evolving crypto developments and promote knowledge sharing and lessons from practical implementation. - Fund work on crypto assets is expected to remain within the agreed budget augmentation framework. ### Policy and regulatory responses — principal recommendations and emphasis - Monetary policy and legal tender: - Strengthen monetary policy frameworks to safeguard monetary sovereignty and stability. - Do not grant crypto assets official currency or legal tender status. - Capital flows and macroprudential: - Guard against excessive capital flow volatility; maintain effectiveness of capital flow management measures. - Fiscal and tax treatment: - Analyze and disclose fiscal risks related to crypto assets; include contingent liabilities in fiscal risk statements. - Adopt unambiguous tax treatment of crypto assets. - Legal certainty and enforcement: - Establish legal certainty for crypto assets and address legal risks. - Develop and enforce prudential, conduct, and oversight requirements for all crypto market actors. - Institutional coordination: - Establish joint monitoring frameworks across domestic agencies and authorities. - Establish international collaborative arrangements to enhance supervision and enforcement of crypto asset regulations. - International monetary system and payments infrastructure: - Monitor the impact of crypto assets on the stability of the international monetary system. - Strengthen global cooperation to develop digital infrastructures and alternative solutions for cross-border payments and finance. - Regulatory approach and sequencing: - Favor comprehensive regulations aligned with standard-setters; avoid piecemeal or fragmented approaches. - Targeted restrictions may be appropriate where domestic objectives or capacity constraints warrant them; strict bans are not the default. - Ensure sequencing and pacing of implementation are tailored to country capacity and circumstances. - Data, monitoring, and capacity building: - Address data gaps; ensure consistent recording of crypto assets in macroeconomic statistics. - Provide country-specific capacity development and prioritize countries with implementation challenges. ### Risks, implementation challenges, and operational notes (selected) - Some implementation challenges include weak regulatory institutions, enforcement difficulties due to offshore providers marketing globally, and heterogeneity across country circumstances. - The framework will not fix underlying crypto design flaws (examples: lack of a credible nominal anchor, payments finality, or scalability). - Enforcement challenges are heightened by cross-border operations of crypto asset service providers. - The Fund is particularly well-suited to advise on macroeconomic risks and to coordinate with standard-setting bodies. *Source: Elements of Effective Policies for Crypto Assets, International Monetary Fund, January 4, 2023.* ### 5. The crypto asset ecosystem is evolving—an important caveat to this paper. Crypto ### 5. The crypto asset ecosystem is evolving—an important caveat to this paper. Crypto ### Overview and paper organization - Crypto assets come in many forms and will likely continue to evolve, including in response to policy actions. - Major data limitations exist, with business models still being developed; effective policies need to be flexible and able to adapt to new developments. - The paper is organized as follows: - Section II sets out definitions and classifications of crypto assets; - Section III discusses purported benefits and potential risks associated with crypto assets; - Section IV puts forward nine core elements of effective policy frameworks that support a comprehensive, consistent, and coordinated framework for crypto assets; - Section V concludes; - Section VI raises issues for discussion. ### Definitions and classification of the crypto ecosystem - There are yet no globally consistent definitions and classification or taxonomy of crypto assets. - Underlying technologies and concepts: - The internet, advanced cryptography, and distributed ledgers (DLT) underlie crypto assets. - DLT is a set of technological solutions that enables a single, sequenced, standardized, and cryptographically secured record of activity to be distributed and maintained by a network of participants. This record could contain transactions, asset holdings, or identity data. - DLT may be closed (permissioned) or open (permissionless). - Permissioned DLT (also known as “closed DLT”) uses a ledger in which the consensus protocol requires participants to be certified by an entity, or a consortium, prior to connecting to the network to read, write, or validate transactions. - Permissionless DLT (also known as “open DLT” or “public DLT”) uses a ledger in which anyone may participate in the consensus protocol, as no central authority can approve or deny participation. - The paper uses a classification based on key features to organize discussion; the aim is descriptive rather than prescriptive and recognizes that features will continuously evolve. ### Categories of crypto assets (as defined in the paper) - Broad definition: Crypto assets are privately issued digital representations of value that are cryptographically secured and deployed using distributed ledger technology. - Three categories highlighted: - Unbacked tokens - Have no backing assets, are usually issued in a decentralized manner, are transferable, have no redemption pledge, and provide no direct claims on the issuer. - With no backing assets, unbacked tokens have volatile prices and are generally not well suited to perform the main functions of money: store of value, medium of exchange, and unit of account. - Examples: Bitcoin (paper focuses on unbacked tokens such as Bitcoin). - Stablecoins - Centrally or decentrally issued crypto assets that aim to have a stable price through reserve assets or through algorithms that respond to demand and supply. - Generally denominated in a monetary unit of account (such as the dollar) and may pledge to redeem into cash at par. - Some stablecoins hold very safe and liquid assets as reserves and offer direct legal claims on the issuer; others may hold risky or illiquid assets or may not offer legal claims. - Direct redemptions can be constrained by withdrawal frequency, fees, and conditions (e.g., minimum withdrawal thresholds). - Many algorithmic stablecoins used in decentralized finance have proven to be volatile. - Examples: USDC (paper focuses on stablecoins such as USDC). - Other tokens - Include utility tokens and security tokens. - Utility tokens: usually centrally issued, provide access to a product or service, limited to a single or closed network, limited transferability (use cases include loyalty programs, access to pre-launch discounts). - Security tokens: usually centrally issued, transferable, and meet the definition of a security within respective jurisdictions (use cases include tokenized equities, fractionalized non-fungible tokens, and initial coin offerings). ### The challenge of legal classification (Box 1 — key points) - Assigning crypto assets to specific legal categories is essential for predictability and enforceability of rights and obligations, market confidence, and effective risk management and supervision. - Legal classification matters for: - Private law: ownership, transfer, lending, pledges, and holders’ rights in issuer or custodian insolvency. - Financial law: determining prudential and resolution regime, competent authority, eligibility for financial safety nets, market conduct rules, and applicability of financial market infrastructure regimes. - Tax treatment: depends on legal characterization (commodity vs. means of payment) and country tax policy. - No generally accepted legal definitions exist; definitions vary by legislation and purpose (examples cited: EU’s MiCA, Japan, Switzerland, Liechtenstein, Ukraine, India, Singapore). - Private law classification can vary: crypto assets could be property, personal claims, or sui generis; unbacked tokens like Bitcoin imply no claim against an issuer. - Applying traditional legal categories is challenging due to digital nature and cross-border DLT nodes complicating jurisdictional choice-of-law. - Financial law classification challenges: crypto assets may be treated as deposit, e-money, payment instrument, security, other financial instrument, or commodity depending on design features and intended use; many authorities apply existing legal categories case-by-case. ### Purported benefits and potential risks — overview - Main purported benefits: improved efficiency (higher speed and lower cost) of payments, innovation, resilience, transparency, and financial inclusion. - Currently, benefits seem tenuous though could materialize through new designs; underlying technological innovations (e.g., smart contracts) could be of value even if crypto assets lack intrinsic value. - Important risks: macroeconomic risks, legal risks, risks to financial integrity and stability, operational and consumer protection risks; some risks are inherent to technology (e.g., DLT) while others arise from lack of policies or enforcement. - Risk significance depends on country circumstances; some risks may not be relevant in all jurisdictions. ### Purported benefits — detailed findings - Cheaper and faster payments potential - DLT can reduce need for intermediaries by enabling joint access, validation, and updates across a network of nodes. - Decentralization replaces some centralized intermediaries but introduces validators who may contribute to transaction costs. - Other intermediaries (exchanges, custodial wallet providers) play important roles in the ecosystem. - Box 2 findings on transaction costs: - Crypto wallets: hosted wallets (third party custody) vs. self-custody wallets (user control). - Hosted wallets often do not post all user transactions on-chain, avoiding blockchain network fees. - Transactions posted on permissionless blockchains incur a network fee paid to miners. - Median Bitcoin network transaction fee over the last three years was $2.72 (Statista). - Median value of Bitcoin transactions is presently $93.61 (CoinDesk), implying a median transaction fee of 2.9 percent (Kaloudis and Young 2022). - This is high compared to most other forms of domestic digital payments and transfers. - Certain cross-border transfers, particularly small-value remittances, regularly incur larger transaction fees: - Average fee for a $200 remittance was 5.7 percent in 2020, with the 75th and 25th fee percentiles equal to 7.7 and 4 percent, respectively (Beck, Janfils, and Kpodar 2022). - World Bank Remittances Prices Worldwide database indicates costs could be double digits for certain corridors. - Crypto assets could be relatively cost efficient for remittances on some corridors, but inclusion of conversion costs between crypto and fiat makes cost efficiency less clear and corridor-dependent. - Evidence suggests traditional intermediaries may be more cost efficient for the US-EU corridor (Goldstein 2021), while crypto has gained market share in other corridors (e.g., U.S.-Mexico). - Technological advances to reduce crypto costs are being developed (Agur et al. 2022), but efficacy is yet to be determined. - Fee comparisons and examples: - CoinBase, Binance, Kucoin, and Bitfinex do not charge fees for intra-exchange retail transfers. - Crypto wallets generally do not charge transaction fees beyond blockchain network fees (examples: Guarda, Trust Wallet, Exodus). - CoinBase Commerce charges a 1 percent payment processing fee to merchants, while Bitfinex Pay and Kucoin do not charge fees to merchants. - In comparison, credit cards typically charge merchants an interchange fee of between 1 to 3 percent, while the fee is lower for debit cards. - Most banks offer credit cards which give cash back rewards of between 1 to 3 percent. - Compliance costs (AML/CFT) for intermediaries, especially in cross-border payments, may affect transaction costs; regulation trends may therefore also affect costs. - Innovation - DLT with open, programmable, and composable architecture can spur private sector innovation; public blockchain source code availability allows reutilization and building new services, promoting diffusion of knowledge and competition. - Operational resilience - DLT systems with multiple copies of ledgers and validating nodes may provide higher operational resilience than centralized entities; if several nodes fail, others can keep the system running. - Trade-off: higher resilience and transparency may come at cost of lower transaction validation speed ("the blockchain trilemma"). - Transparency and traceability - Public DLTs allow blockchain analytics to identify illicit transactions using automated triggers; regtech and suptech can enhance compliance and supervision. - Challenges for analytics include geo-blockers, off-chain transactions, and privacy-enhancing mechanisms. - Financial inclusion potential - DLT could improve access for unbanked populations and lower prices and fees for small-value cross-border transactions in some corridors (see Box 2). - However, high costs to cash in and cash out, need for digital literacy, and internet connectivity likely reduce financial inclusion potential. *Source: ppea2023004 - Excerpt titled "5. The crypto asset ecosystem is evolving—an important caveat to this paper. Crypto"* ### 15. Unbacked tokens have been used to enhance portfolio diversification, but this ### 15. Unbacked tokens have been used to enhance portfolio diversification, but this potential use has decreased over time. ### Correlation and diversification - The prices of these tokens have become more correlated with other financial assets as they have become more mainstream and held by financial institutions (FSB 2022; Iyer 2022). - This increased correlation has reduced their usability for diversification purposes. ### Potential risks — Macroeconomic - Widespread adoption of crypto assets could threaten the effectiveness of monetary policy. - The transmission of monetary policy would weaken if firms and households prefer to save and invest in crypto assets that are not pegged to the domestic fiat currency (IMF 2020). - The risk of currency substitution (“cryptoization”) is particularly pertinent for countries with unstable currencies and weak monetary frameworks. - Cryptoization is more likely to be associated with adoption of stablecoins denominated in foreign currencies which can offer a less volatile alternative to the domestic currency. - Decentralized and anonymity features of certain crypto assets: - Make regulation challenging. - Ease accessibility and potential use for circumventing existing capital control measures. - May incentivize substitution to crypto assets rather than reserve currencies like the dollar or euro. - Adoption of crypto assets as official currency or legal tender may further incentivize their adoption and weaken monetary policy effectiveness. - Crypto asset usage could affect capital flows’ volume and volatility: - If crypto assets have lower cross-border transaction costs, they may create additional incentives for investors to allocate capital across borders. - Gross capital flows could increase, as could capital flow volatility, given the large price volatility of unbacked tokens and potential for herding behavior. - Although global crypto asset trading volumes remained relatively small compared to other financial market transactions, crypto-related capital flows could be significant for countries where local adoption is relatively high (Chainalysis 2022). - Crypto assets could erode the effectiveness of capital flow measures (CFMs): - Crypto assets may not be covered by existing CFM laws and regulations; authorities may lack mandates and powers to control their use. - For pseudonymous crypto assets, prosecution and sanctioning may be difficult. - Crypto asset trades may not involve intermediaries or service providers subject to CFM laws and regulations or able to verify identities and transaction nature. - Crypto asset service providers might not be regulated; existing CFM enforcement through regulated entities is thus limited (He et al. 2022). - Potential impact on the international monetary system: - Strong correlations between payment currency and reserve currency shares suggest payment adoption of crypto assets might eventually lead to demand for crypto asset reserves. - A significant increase in crypto efficiency and payment usage would be necessary before a material change in existing reserve configuration. - Illustrative network-model analysis suggests crypto asset-induced shocks could result in substantial reserve losses across the international monetary system, leading to increased demand for Global Financial Safety Net resources. - Fiscal risks: - New fiscal risks can arise from the financial sector’s exposure to the crypto assets ecosystem, lack of clarity of tax regimes, and the extra-territorial nature of crypto assets. - Wide adoption in a weakly regulated environment could increase explicit and implicit fiscal risks from the financial sector. - Pseudonymous crypto assets can affect tax revenue collection and compliance; withholding taxes and third-party information are challenging. - Decentralized peer-to-peer (P2P) activities increase reliance on voluntary compliance and self-reporting. - Supervised institutions required to report crypto-related activities may not capture institutions that are unregulated or reside abroad. - Granting crypto assets official currency or legal tender status — macro-critical consequences: - Creditors would be required to accept it in payment of monetary obligations, including taxes. - If goods and services are priced in both an official currency and a crypto asset, households and businesses would spend significant time and resources choosing which money to hold instead of engaging in productive activities; domestic prices could become highly unstable. - Even if all prices were quoted in a crypto asset, prices of imported goods and services would still fluctuate massively following market valuations. - Granting legal tender would amplify fiscal risks: - If a crypto asset not pegged to the domestic fiat currency, or whose peg may not be sustainable, is adopted as official currency or legal tender, government revenues may be exposed to exchange rate risk if taxes or non-tax revenues are quoted in advance in a crypto asset while expenditures are primarily made in the local currency. - Contingent liabilities arise if convertibility to fiat currency is guaranteed by the government, especially if operationalization involves public digital e-wallets and trust funds held in public development banks. - Adoption as official currency or legal tender could affect social policy objectives; unbacked tokens’ high price volatility could affect poor households more. - Use as legal tender could significantly impact public financial management (e.g., treasury single account operations, liquidity management, fiscal reporting, measurement of value, and accounting), potentially weakening active cash management and affecting reliability of fiscal reports. - Taxpayers may gain tax advantages where application of tax laws to crypto asset transactions is uncertain or incomplete; cross-border transactions heighten risk of tax avoidance and evasion due to differences in classification across jurisdictions. - Legal tender status legal issues: - Legal tender requires wide accessibility, but internet access and technology to transfer crypto assets remain scarce in many countries, raising fairness and financial inclusion issues. - The official monetary unit must be sufficiently stable in value to facilitate medium- to long-term monetary obligations. - Changes to legal tender status and monetary unit typically require complex and widespread changes to monetary law to avoid a disjointed legal system. ### Potential risks — Financial Stability - Unbacked tokens and stablecoins without credible backing may pose financial stability risks: - Sharp declines in crypto asset prices can have large negative effects on the balance sheets of investors. - Financial institutions may hold crypto assets directly for trading, custodial, or market-making activities. - Indirect exposures arise if institutions provide credit or other services to crypto trading platforms and wallet providers, institutional or retail investors, or accept crypto assets as collateral for lending. - Rapid adoption may pose financial stability and credit provision concerns due to changes in bank funding models; spillovers may materialize if financial institutions are closely connected. - Ecosystem governance risks: - DLT allows governance rights to be decentralized through governance tokens (Aramonte et al. 2021). - Governance tokens traded on the market can enable an attacker who gathers enough voting rights to impose policies that allow draining funds from users (Wharton 2021). - Due to current lack of regulation, draining of funds is currently not penalized. - Crypto asset platforms with open architecture — cyber and operational risks: - Open DLT architectures allow anyone to create malicious protocols or protocols with bugs. - Complexity means many applications with bugs become widely used before discovery; users have incentives to exploit bugs rather than report them. - Self-custody wallets create additional risk of password loss; combined with lack of regulation, recourse is not possible. - One estimate puts the share of Bitcoin lost in wallets at 17-23 percent of all mined Bitcoin; individual investor losses worth hundreds of millions of U.S. dollars have been documented. - Bank funding model risks: - Banks typically rely on retail depositors; if crypto adoption rises, banks might have to pay higher rates on deposits or shift funding to more expensive, less stable wholesale funding, potentially taking on greater risks to support profits. ### Potential risks — Financial Integrity - Pseudonymous nature raises financial integrity risks: - Although many DLT network transactions are public, linking an address or wallet to an individual can be challenging. - Value of crypto assets involved in most criminal cases detected so far has been relatively small compared to traditional financial products, but some known misuse cases involve relatively large amounts (FATF 2021). - Crypto assets can be misused for fraud, theft, tax evasion, terrorist financing, corruption, and money laundering. - Alnasaa et al. (2022) find crypto asset usage is significantly and positively associated with higher perceptions of corruption. ### Potential risks — Legal - Legal classification and application of existing rules pose significant challenges and uncertainty: - Uncertainties in private laws (e.g., insolvency law) could result in parties facing different risks than envisaged at the time of transaction. - Holders of crypto assets could face recharacterization of their rights as unsecured personal claims instead of proprietary rights in the event of intermediary insolvency, which could give rise to financial instability if large-scale. - If not clearly included in existing financial law classifications, a crypto asset may fall entirely or partially outside the regulatory framework, leading to regulatory arbitrage or inadequate handling of financial stability risks. - Uncertainties may expose the private sector to unpredictable supervisory actions, curbing financial innovation, and expose regulatory authorities to risk of successful legal challenges due to broad interpretation of mandates. - Legal risks, including conflict of law challenges, are heightened in cross-border transactions due to differences in legal classification and treatment across jurisdictions. - These risks are even more evident in fragile states with high levels of corruption and weak rule of law. ### Potential risks — Consumer protection - Consumer protection risks arise when consumers and investors are unaware of or do not fully comprehend risks associated with crypto assets: - Risks stem from inadequate governance, opaque decision-making processes, and limited recourse when regulation is insufficient. - Risks may also arise from price volatility, fraud, or cyber-attacks. - The filing for bankruptcy protection in November 2022 by FTX revealed risky investments, inadequate governance, and opaque corporate interlinkages; the run on FTX exerted significant spillovers on major crypto assets and impacted decentralized finance and stablecoin markets, ultimately impacting investors. - The fallout of TerraUSD (UST) in May 2022 highlighted significant investor risks; the stablecoin experienced significant redemptions culminating in breakdown of the entire Terra ecosystem. ### Potential risks — Market integrity and contestability - Market contestability issues: - Permissionless crypto assets’ scalability constraints may cause congestion, leading to high transaction costs and fragmentation (BIS 2022). - Multiple blockchains may generate interoperability problems. - Permissioned DLT markets are prone to concentration risks and market power due to network value and returns to scale. - Permissioned platforms, including for digital currencies issued by “big techs,” could use networks to shut out competitors and monetize information using proprietary customer transaction data. - Consensus and concentration: - In permissionless blockchains, consensus mechanisms may favor concentration (e.g., under proof-of-stake, richer individuals or entities with more crypto assets to stake are more likely to be selected to validate and receive compensation) (Bains 2022). - Scalability consequences: - Scalability constraints can make it difficult to withdraw and transfer funds during runs and may cause transaction fees to skyrocket (example: on April 21, 2021, Bitcoin transaction fees peaked at $62.79). *International Monetary Fund — Elements of Effective Policies for Crypto Assets (excerpts from section 15).* ### 31. Crypto assets are also prone to manipulation and therefore to fraud and market ### ppea2023004 - 31. Crypto assets are also prone to manipulation and therefore to fraud and market ### Risks: manipulation, market integrity, settlement finality, and environmental impact - Crypto assets are prone to manipulation and therefore to fraud and market integrity risks. - In permissionless DLT, users can set the fees of their own transactions to rank higher or lower in the settlement queue and obtain financial gains. - Large validators could congest the blockchain with artificial trades, raising the fees that other users pay them. - Illiquidity of certain exchanges or crypto assets may facilitate price manipulations — to trigger liquidations and purchase liquidated collateral at a discounted price or short the collateral asset. - Many types of consensus mechanisms that underpin public blockchains can only deliver probabilistic settlement due to the possibility of forks in the blockchain, which might cancel earlier transactions. - Crypto assets based on proof-of-work consensus mechanisms are highly energy intensive and generate large amounts of e-waste. - Note: Other consensus mechanisms may be much more energy efficient than proof-of-work, and if properly designed, DLT may be more energy efficient than existing payment systems. ### Policy framework overview - The paper proposes a policy framework comprising nine elements to address the risks and harness the potential benefits of crypto assets. - The first three elements relate to macrofinancial risks. - The next three address risks to legal certainty; safety, and soundness of the financial system; financial integrity; consumer, and investor protection; and market integrity and contestability. - Elements seven to nine address the importance of enhanced global coordination and collaboration, given the extra-territorial nature of unbacked tokens and stablecoins, and envision the use of technological innovations for public policy purposes, such as enhancing cross-border payments. - Country circumstances and capacity constraints may condition the sequence of implementing the elements of this framework. ### Element 1: Safeguard monetary sovereignty and stability - Strengthen monetary policy frameworks (MPFs) and do not grant crypto assets official currency or legal tender status. - Robust macroeconomic policies and credible institutional frameworks are the first line of defense to protect monetary sovereignty and stability. - A weak MPF, combined with large fiscal deficits and government pressures for central bank financing, are likely to undermine monetary credibility and instigate currency substitution. - An effective MPF should be transparent, coherent, and consistent; it encompasses design, implementation, communication, and legal foundations for central bank independence and accountability. - Avoid large deficits and high debt levels to protect monetary sovereignty, especially in the context of weak MPFs. - Crypto assets should not be recognized as “currency”; unbacked crypto assets and privately issued stablecoins should not be recognized as “currency.” - Crypto assets with official currency or legal tender status could increase adoption and exposures of banks and other regulated financial institutions, amplifying risks. - Central banks should not hold unbacked crypto assets or privately issued stablecoins as part of their official reserve assets. - If a crypto asset is granted official currency or legal tender status, governments should minimize their exposure to fiscal and operational risks, minimize use for official payments, avoid guarantees on convertibility, and identify and manage risks to fiscal management operations with adequate safeguards, controls, and procedures. ### Element 2: Guard against excessive capital flow volatility and preserve CFMs - Policy makers should contemplate measures to counter the erosion of capital flow measures (CFMs) arising from crypto asset adoption. - Clarify the legal status of crypto assets and ensure that CFM laws and regulations cover crypto assets and are effectively applied to the various actors in the crypto ecosystem, ideally also abroad. - Address data gaps and apply new regulatory and supervisory technologies to create anomaly detection models and red-flag indicators to facilitate timely risk monitoring and CFM implementation. - Greater exchange rate flexibility may be needed if CFMs become less effective; countries may face a tradeoff between monetary autonomy, exchange rate stability, and financial openness. - Managing increased risk of sudden capital outflows could involve recalibration of international reserves; central banks may judge that the optimal level of reserves has risen, which could require adjustments in the macroeconomic policy mix, such as tighter monetary and/or fiscal policies. ### Element 3: Analyze and disclose fiscal risks; adopt unambiguous tax treatment - Fiscal risks in the financial sector generated by the adoption of crypto assets should be analyzed, quantified, disclosed, and monitored as part of government fiscal risk management. - The exposure of the government to fiscal risks emerging from crypto assets should be properly quantified and monitored in a timely fashion. - Information on fiscal risks from crypto assets should be included in the government’s fiscal risk statement as part of budget documentation submitted to lawmakers to promote fiscal transparency. - Tax policy should ensure an unambiguous tax treatment of crypto assets; tax administrations must reinforce tax compliance. - Specific regulations are required to clarify the tax treatment of crypto assets, both for income/wealth and value-added taxes. - Tax administrations should exploit opportunities to use third-party information where feasible (e.g., exchange providers, brokers, dealers, or central settlement). - Foster collaboration on cross-border information sharing and financial regulations; consider following the Crypto Asset Reporting Framework (CARF) proposed by OECD. - Improve institutional capacity, including investments in specialized data infrastructure and analytics, and prioritize training and technical capabilities of tax administration staff. ### Element 4: Establish legal certainty and address legal risks - Jurisdictions should consider three actions to establish legal certainty (not mutually exclusive and may involve law reforms with private sector participation): - Modernize private law through targeted legislative reforms to clarify classification of crypto assets and rules governing transactions. - Clarify financial law treatment of crypto assets by enforcing existing frameworks where applicable, amending existing laws to explicitly cover certain activities, or issuing bespoke laws on crypto assets (examples cited in source). - Mitigate the tax risk from transactions involving crypto assets by ensuring transparent and predictable tax law frameworks, complemented by international cooperation and timely guidance to taxpayers and crypto asset service providers on payment and reporting obligations. ### Element 5: Prudential, conduct, and oversight requirements - Comprehensive regulation is preferable to outright bans. - Crypto asset service providers should be licensed, registered, or authorized. - Entities providing storage, transfer, exchange, custody of reserves and assets should be subject to rules similar to those applied to financial service providers, with additional requirements to reflect new business models. - Licensing and authorization criteria should be clearly articulated, responsible authorities clearly designated, and coordination mechanisms among them well defined. - Where global standards exist, authorities should implement these standards into domestic regulation (e.g., FATF standards on AML/CFT; IOSCO guidance on exchanges). - Standards should encompass both the safety of the underlying assets and the network that facilitates transfer of the assets. - Guidance may be drawn from CPMI and IOSCO’s Principles for Financial Market Infrastructures (PFMI) to address issues related to transfer, governance, and risk management of infrastructure and networks, and the safe settlement of assets. *International Monetary Fund — Elements of Effective Policies for Crypto Assets (selected sections).* ### Box 3. The Rationale for Comprehensive Regulations ### Box 3. The Rationale for Comprehensive Regulations ### Rationale for comprehensive regulation versus blanket bans - Comprehensive regulations are preferred to blanket bans because they address specific features of crypto assets that generate externalities (e.g., high degrees of anonymity facilitating illicit transactions; environmental burden when proof-of-work consensus mechanisms are used). - Regulation is needed to address internalities—cases where consumers do not fully take into account the costs of using or holding crypto assets (e.g., volatility in value, possible losses due to cyber-attacks).1 - Issuing warnings and increasing the availability of information can be helpful but may not be sufficient to address externalities and internalities; moreover, such measures can provide legitimacy to the market and facilitate links with wider financial services that could generate systemic risks without adequately addressing them. - Blanket bans that make all crypto asset activities (e.g., trading and mining) illegal may: - Stifle innovation and drive illicit activities underground. - Increase difficulty for policymakers to learn about potential productive innovations and to mitigate risks (including financial integrity risks). - Be costly to enforce and increase incentives for circumvention due to the borderless nature of crypto assets, potentially heightening financial integrity risks and creating inefficiencies. - Decision to ban should be informed by an assessment of money laundering and terrorist financing (ML/TF) risks, and other considerations such as large capital outflows and other public policy aims. - Regulations imply certain forms of crypto assets remain available legally, increasing substitutability between legal and illegal assets relative to blanket bans; when legal substitutes are scarce, users may be more motivated to access illegal markets and willing to pay higher prices, increasing profits for circumvention and enforcement costs—and reducing economic efficiency.45 ### When targeted restrictions or temporary bans may be justified - Targeted restrictions could be justified to manage specific risks, for example where countries experience: - Large capital outflows - Significant currency substitution - An unacceptable level of ML/TF risk - Risks to consumers and markets - Targeted restrictions can be aimed at: - Certain products (e.g., privacy tokens) - Certain activities (e.g., payments in Ukraine) - Financial promotions (e.g., in Singapore, Spain, U.K.) - Products such as crypto derivatives (e.g., in Japan and the U.K.) - Broader bans could be considered only over a shorter time horizon; targeted restrictions might be warranted in the short run while countries increase internal capacity (including knowledge and awareness) in anticipation of regulation. - Even temporary restrictions should be part of a larger policy framework and not substitute for robust macroeconomic policies and credible institutional frameworks—the first line of defense against macroeconomic and financial risks posed by crypto assets. ### Relevant authorities and international guidance - Depending on domestic legal framework, type of regulation, and nature of the product (such as unbacked tokens or stablecoins), relevant authorities could include banking regulators, payment system regulators, securities regulators, financial intelligence center authorities, or tax authorities.46 - In October 2022, the FSB published proposed frameworks for the international regulation of crypto-asset activities. Further guidance has been provided by BCBS, CPMI and IOSCO, and FATF on applying existing and new standards to crypto-assets. ### Elements of effective policies—consumer protection and conduct (selected points) - Conduct requirements should focus on points that directly impact end users, especially key entities such as exchanges, wallet providers, issuers (where known), governance bodies (where applicable), and regulated financial institutions participating in crypto markets.49 - Wallet administration must be secure with clear risk management frameworks; safekeeping and segregating funds legally and operationally, and safeguarding through private insurance against cyber risks, can support consumer protection in stressed market periods. - Effective wind-down frameworks for wallet failures can help manage end-user risks. - Exchanges may be required to consider suitability requirements for users; user education is an important short-term regulatory tool. - Market abuse rules and surveillance mechanisms should be considered to adequately protect users. ### Disclosure and transparency - Appropriate disclosure and transparency requirements are key: - Marketing information should be clear, balanced, and indicate if products are regulated in the local market. - White papers should provide clear, accurate, and understandable explanations of the crypto assets issued and essential information such as key personnel (importance highlighted by the FTX/Alameda Research case). - Entities should be transparent about activities and operational functions that might impact markets and consumers. - Third party audits can ensure disclosure accuracy; regulations should grant the power to establish scope of external audits and standards to follow. ### Entity-level regulation, conflicts of interest, and systemic designation - Crypto asset service providers offering multiple core functions should be regulated based on risks generated by the entity as a whole and across activities; conflicts of interest must be addressed. - Additional prudential, conduct, and payment system regulations should reflect the nature of all risks; regulators may establish requirements where providers offer infrastructure-like services such as clearing and settlement (FTX cited as an example of opaque interlinkages and conflicts of interest). - If designated as systemic, crypto asset service providers should be subject to additional oversight and adhere to the PFMI when performing payment functions.47 - For stablecoin arrangements, systemic importance can be determined by domestic regulators based on factors such as: - Size of the stablecoin arrangement (in terms of number of users and value/volume of transactions) - Nature and risk profile of the arrangement’s activity - Interconnectedness and interdependencies with the real economy and financial system - Availability of alternatives to using the stablecoin arrangement as a means of payment or settlement for time-critical services.48 - Identification and designation of systemically important crypto service providers can be complex and should be viewed holistically by domestic regulators. ### Outsourcing, operational resilience, and cyber risk - Authorities should address risks from outsourcing to third parties, including operational failures and cyber incidents. - Many authorities require wallet providers to ensure robust cybersecurity frameworks for custodied crypto assets; key entities should have effective incident management procedures, including detection and classification of major operational and security incidents. - Reporting of operational or cyber incidents needs to be timely and accurate. - Where cyber or operational processes are delegated, the wallet provider should remain responsible for incidents in third parties, with clear outsourcing requirements in place. - The BCBS Principles on Operational Resilience could be applied to key crypto asset service providers, particularly exchanges and wallets; for stablecoin arrangements identified as systemically important FMIs, published guidance on cyber resilience for FMIs needs to be applied.49 ### Stablecoins—ecosystem-wide and governance considerations - Requirements for stablecoins should be tailored to address risk across the entire ecosystem, including: - (i) issuance, redemption, and stabilizing mechanisms - (ii) the transfer function - (iii) access - Key regulatory focus should be on stablecoins’ reserve assets and capital to address credit, market, operational, liquidity, concentration risks, and the rights of stablecoin users over reserve assets. - Regulatory approaches can take cues from similar products and business (e.g., commercial banking, e-money, FMIs, money market funds) while addressing novel risks; a combined conduct, payment, and prudential regulation modeled on similar products may be sensible. - Clear and robust governance requirements are essential, especially for stablecoin arrangements: - Governance should cover “fit and proper” senior management, resources and control functions, and identifiable decision-making structures promoting safety and efficiency. - Where redemption depends on third parties, the governance body must have clear plans to ensure redeemability in case of third-party failure. - Conflict of interest management is critical where non-bank stablecoin issuers engage with lending services. - Third party audits of reserves should be mandatory to show proof of reserves. - Where stablecoin arrangements become systemically important, authorities should analyze and adjust the regulatory framework and apply requirements comparable to those for systemically important banks (e.g., more intensive supervision, stress testing, recovery planning, resolvability), taking into account differences in business models.50 - Consideration of access to the financial safety net could be warranted when stablecoins reach systemic scale or commercial banks issue their own stablecoins/tokenize deposits, subject to safeguards. ### Prudential treatment of regulated financial institutions - Authorities should provide clear prudential requirements on regulated financial institutions (e.g., banks and insurers) concerning exposure to and engagement with crypto assets: - Banking, securities, insurance, and pensions regulators should stipulate capital and liquidity requirements and limits on exposures. - Financial institutions should monitor indirect exposures (e.g., loans to crypto users, derivative exposures with crypto asset exchanges, cyber insurance to wallet providers) because indirect exposures can be strongly correlated with market movements. ### Financial integrity—AML/CFT and virtual assets - To address financial integrity risks, countries should implement FATF standards on AML/CFT which explicitly address crypto assets (referred to as virtual assets, VA): - Countries must identify and assess ML/TF risks associated with VAs and take appropriate steps to manage and mitigate those risks. - Ensure relevant laws, including criminal laws, cover VAs. - Ensure relevant authorities have necessary powers to pursue crimes involving VAs, sanction perpetrators, and freeze, seize, and confiscate VAs when warranted. - Unless banned, VA-related services listed in FATF standards should be regulated and their providers subject to AML/CFT obligations (including customer due diligence, transaction monitoring, and reporting of suspicious transactions) and supervised for AML/CFT purposes. - All stakeholders (e.g., AML/CFT supervisors, law enforcement agencies, private sector) should work in a coordinated manner. - Authorities may prohibit listing of certain crypto assets that use technology to completely mask user identification. ### DeFi, P2P transactions, and monitoring - Countries need to monitor and mitigate ML/TF risks related to decentralized finance (DeFi) projects and peer-to-peer (P2P) transactions: - P2P transactions may not involve intermediaries or AML/CFT obliged entities; intermediaries may be absent or difficult to identify in DeFi contexts, making traditional AML/CFT approaches inapplicable. - The potentially substantial volume of P2P transactions and the rise of DeFi call for creative risk mitigation.51,52 - Possible measures include requiring intermediaries to apply enhanced AML/CFT measures when dealing with unhosted wallets, and identifying intermediaries in the DeFi context that can be regulated and held accountable for AML/CFT controls.53 - Continual monitoring of P2P transactions and the DeFi space by countries and the FATF is needed to ensure risks are mitigated and guidance is provided. - If properly used, digital tools can improve AML/CFT effectiveness, but are not silver bullets: - Digital ID, blockchain-based regtech and suptech can facilitate effective AML/CFT controls, trace flows, and detect suspicious transactions. - Important limitations remain: off-chain transactions may not be traceable; anonymity-enhancing features or mechanisms to hide critical information will hinder implementation of measures like customer due diligence.54 ### Joint monitoring and institutional coordination - Establishing joint monitoring across authorities is a useful first step to better understand crypto ecosystem developments. - While comprehensive regulation is the first best option, unique jurisdictional challenges may warrant a “constrained best solution”; irrespective of approach, authorities with different mandates may all have interest in developing deeper understanding of crypto developments. - Existing regulatory and supervisory frameworks (e.g., for AML/CFT) remain important mechanisms to aid understanding of crypto asset activities and can provide information useful for other regulatory purposes. - Frequent engagement with the crypto industry, through innovation hubs and regulatory sandboxes, can help authorities understand actors, activities, risks, and use cases. *International Monetary Fund — Elements of Effective Policies for Crypto Assets, Box 3. The Rationale for Comprehensive Regulations* ### Box 4. Potential Implementation Challenges ### Box 4. Potential Implementation Challenges ### Key implementation constraints - Lack of sufficient and appropriate resources: - Many authorities are experiencing a shortage of resources and expertise. - Authorities need to choose and allocate these scarce resources to areas with highest priority or highest risk. - Example: Effective implementation of the FATF standards on AML/CFT requires a sound assessment and understanding of the ML/TF risks associated with crypto assets, which in many instances remains limited and underdeveloped, sometimes due to resource shortages. - Authorities should consider implementing some elements with higher importance, including those with fiscal impact, and defer implementing others. - Lack of data: - Due to a lack of comprehensive and comparable data, most authorities struggle to accurately assess the scale and types of risks posed by the misuse of crypto assets, and to identify appropriate regulatory responses. - Differences in taxonomies can hinder data comparisons across jurisdictions. - Fragmented implementation: - A lack of a common taxonomy can limit the timeliness of implementation of recommendations, guidance, and standards related to crypto assets. - The speed and level of implementation can differ across jurisdictions, creating opportunities for regulatory arbitrage (as evidenced by the implementation of the FATF standard on AML/CFT). - Some global standards are tailored toward advanced economies and might not reflect the challenges facing emerging and developing countries (such as risks of cryptoization). ### Cross-border and jurisdictional challenges - Cross-border nature: - Many crypto asset service providers are located in offshore jurisdictions with limited capacity or history of international cooperation while marketing services globally, creating significant challenges for authorities where users are located and possible scope for tax avoidance or evasion. - Onshoring requirements exist in some jurisdictions to subject entities to regulation, but these can be challenging and difficult to enforce. - Some authorities create public communication channels to ensure the public is aware of which entities are licensed domestically and which are unlicensed and foreign, informing the public about the lack of recourse to compensation when dealing with foreign crypto entities. - Fostering collaboration on cross-border sharing is critical for tax compliance. - Legal challenges: - A critical challenge when adopting legal reforms is maintaining a level of flexibility to allow for the rapidly evolving technology in the crypto ecosystems, while still providing sufficient legal certainty. - Challenges with novelty: - Some requirements may be difficult to implement; for instance, the so-called Travel Rule1 in the FATF Standards on AML/CFT raises implementation challenges that require greater technological knowhow and collaboration to be overcome. ### Pragmatic implementation approach and prioritization - Authorities should implement necessary elements in a pragmatic manner, taking into account jurisdictional contexts and idiosyncratic constraints. - Authorities face various constraints and need to explore a “constrained best solution.” - The constrained best solution is likely to be national frameworks guided by global standards and best practices, supplemented by a mix of targeted restrictions where global standards have not been completed and supervisory capacity is lacking. - Public communication and other soft measures can help supplement and fill outstanding gaps. - Prioritization under rapid uptake: - The nine elements work together to create a holistic framework, but some elements may be more important than others depending on the rate of adoption. - A starting point is establishing legal certainty within both private and public law. - Following legal clarification, comprehensive and consistent regulations are preferable, but under specific circumstances, targeted restrictions may be considered as an alternative (as discussed in Box 3). ### Data, monitoring, and statistical recording - Authorities should collaborate on data collection and analysis to improve monitoring capacities. - Consistent and reliable data are important for monitoring and enforcement. - The fragmented approach to categorizing crypto assets can inhibit the reliability and availability of data. - The FSB and other standard setters are well placed to develop common global taxonomies. - Current limitations in reporting: - Reporting of crypto asset data is largely limited to voluntary reporting or reporting under AML/CFT frameworks. - Gaps in reporting exist, including off-chain transaction data from entities that perform critical functions, such as crypto asset service providers. - Some authorities are beginning to work with blockchain analytics firms to better understand the flow of funds through a crypto asset value chain and where significant limitations exist (for example, off-chain data collection and the use of virtual private networks).55 - Data collection should be made more consistent across borders, and collected data should be shared among relevant home and host authorities. - Need for statistical methodology and data framework: - There is a need to develop a data collection framework to support consistent recording in macroeconomic statistics across economies. - Work is ongoing on the development of a statistical methodology on the recording of crypto assets in macroeconomic statistics, in the context of the ongoing update of international statistical standards.56 - The new G20 Data Gaps Initiative, recently welcomed by the G20 leaders,57 includes a recommendation for the development of a data collection framework for crypto assets. ### International collaboration, supervision, and enforcement - Borderless crypto-asset ecosystem limits national approaches: - Crypto asset service providers have incentives to register in “regulatory friendly” locations from which they provide platforms for global markets (example: FTX was domiciled in The Bahamas but offered crypto related services across the globe). - Jurisdictions wishing to regulate crypto services may not have sufficient information or powers to enforce restrictions and need to cooperate with crypto exchanges’ home regulators. - International collaboration and information sharing are required to minimize regulatory arbitrage and ensure continued effectiveness of regulatory policies. - Authorizing and regulating foreign-domiciled providers: - Mechanisms need to be developed for domestic authorities to authorize and regulate crypto service providers legally domiciled in foreign jurisdictions. - Under the FATF recommendations, virtual asset service providers (VASPs)58 should be registered or licensed at least in the jurisdiction where they are created (as legal persons) or where the place of business is located (for natural persons) and supervised for AML/CFT purposes. - Customers in a given country can easily access services of a service provider not authorized by that country; countries may need ways to authorize and regulate providers that offer services in their jurisdiction, even if providers are legally domiciled elsewhere. - Enforcement may be challenging for regulators with capacity or technological constraints. - Information exchange and supervisory cooperation: - A clear legal basis must underpin the exchange of information and cooperation, including between AML/CFT competent authorities, even for countries that have restricted or banned virtual asset-related activities. - Cooperation between AML/CFT supervisors is critical, and establishing AML/CFT supervisory colleges can facilitate information sharing and exchange of views among supervisors of VASPs operating in multiple jurisdictions. - Sharing of information and knowledge among countries is critical for improving understanding of ML/TF risks related to crypto assets at the global and country levels. - Many countries have not yet implemented the FATF standards related to crypto assets, and amongst those that have, many are struggling to implement them effectively; uneven and inconsistent implementation creates opportunities for regulatory arbitrage and challenges in implementing certain requirements, such as those governing the transfer of virtual assets.59 - Considerably more efforts are needed globally to implement the FATF standards effectively. - Adapting existing cooperative arrangements: - Existing cooperation protocols—such as bilateral MoUs, multilateral MoUs, and supervisory colleges for systemically important financial institutions—are well established and should be expanded to cover the crypto ecosystem. - New supervisory colleges can be created where an entity wants to launch a potentially globally systemic crypto service.67 ### Monitoring systemic impacts and IMF role - Need for continuous monitoring of crypto assets’ impact on the international monetary system (IMS): - The IMS may be entering a chapter with major challenges, such as excessive fragmentation, large and volatile capital flows, and new risks to financial stability and integrity; crypto assets could amplify existing vulnerabilities and pose new risks on multiple fronts. - Areas needing close and ongoing monitoring include: - (i) crypto assets’ impacts on gross and net cross-border capital flows; - (ii) changes in financial intermediation, currency substitution, and international currency use; - (iii) effects of exchange rate and capital account regimes as well as capital flow management measures; - (iv) financial integrity risks; and - (v) demand for and supply of Global Financial Safety Net resources. - Close monitoring will help inform appropriate regulation and cross-border cooperation among policymakers and international standard setting bodies and institutions. - IMF support: - The IMF will help by monitoring macrofinancial and spillover risks through active engagement with member countries via surveillance, lending facilities, and capacity development support. - The IMF, with its worldwide membership and technical assistance, can also help bridge the digital divide by supporting countries with their technical challenges. ### Digital infrastructure, cross-border payments, and public-sector roles - Digital public infrastructure opportunities: - Underlying technologies of crypto assets could be used to facilitate the development of digital infrastructures and address existing inefficiencies in financial services. - Digital public infrastructure includes interoperable digital platforms, digital identification systems, digital payments, and trusted data sharing. - Cross-border payments inefficiencies and G20 roadmap: - Cross-border payments face high fees, slow transaction times, lack of transparency, and limited accessibility. - G20 finance ministers and central bank governors endorsed a “roadmap” in October 2020 to enhance cross-border payments (FSB 2020); the roadmap splits necessary improvements into 19 building blocks (BBs) that the IMF and other institutions are actively developing. - The last three BBs focus on: BB17 exploring new multilateral platforms and arrangements for cross-border payments; BB18 fostering the soundness of global stablecoin arrangements for cross-border payments; and BB19 factoring an international dimension into central bank digital currency design. - Policy framework to support improvements: - The proposed policy framework creates conditions that allow for innovation in digital money while managing risks. - Important elements include macroeconomic, regulatory, and oversight requirements to ensure safety of the international monetary system; a consistent legal basis and coherent fiscal, monetary, and regulatory policies; standards for technology interoperability; and policies to ensure capital flow measures and monitoring remain effective when transactions shift to digital money. - Public-sector roles beyond regulation: - The public sector can build, operate, or supervise digital infrastructure to facilitate cross-border payments. - New networks and platforms leveraging tokenization, encryption, and programmability could improve transaction efficiency (Adrian et al. 2022). - The public sector might issue central bank digital currency utilizing technologies developed by crypto asset programmers, which could offer benefits but also raises a range of complex policy and technical issues beyond the scope of this paper. ### Conclusion highlights - The paper proposes nine elements along three dimensions to inform a comprehensive, consistent, and coordinated policy framework for crypto assets to guide staff policy advice, capacity development, and participation in standard-setting discussions. - Dimension 1 (macro-financial considerations): - Emphasizes monetary, capital flow management, and fiscal aspects. - Where widely adopted, crypto assets could instigate currency substitution. - The first line of defense is ensuring sound and effective monetary and fiscal policy, and not declaring privately issued crypto assets as national currency. - Dimension 2 (domestic regulatory, supervisory, and oversight requirements): - Starts with establishing legal certainty within private and public law. - Generally best to implement comprehensive and consistent regulations; targeted restrictions may be necessary in certain circumstances. - Provides recommendations on prudential, conduct, and oversight requirements to develop consistent domestic approaches to avoid duplication and prevent arbitrage. - Dimension 3 (global coordination and technology use for public policy): - Highlights global coordination, monitoring the impact on the IMF, and developing alternatives for cross-border payments as priorities. - The public sector should act as a strong catalyst to leverage emerging technologies to improve cross-border payments. *Source: Box 4. Potential Implementation Challenges — ppea2023004* ### 79. Finally, the paper acknowledges the heterogeneity across jurisdictions, including ### ppea2023004 - 79. Finally, the paper acknowledges the heterogeneity across jurisdictions, including ### Heterogeneity, pragmatic regulation, and limits of regulation - A “constrained best solution” and pragmatic approach to regulation is recommended. - Country circumstances and capacity constraints may affect the pace and the sequence of implementation. - Regulations and broader policies toward crypto assets will not fix underlying design flaws such as: - the lack of a credible nominal anchor; - payments finality; - scalability. ### Issues for discussion (selected questions) - Do Directors agree with the purported benefits and potential risks described in paragraphs 9–32? - Do Directors agree with staff’s proposal on nine elements to inform a comprehensive, consistent, and coordinated policy framework for crypto assets? - Do Directors agree that this framework should be used to guide staff’s policy dialogue with country authorities and capacity development activities, and participation in discussions with standard-setting organizations? ### Annex II — Standards and guidance by standard-setting bodies (key points) - Basel Committee on Banking Supervision (BCBS): - In December 2022, the BCBS finalized its standard on prudential treatment of crypto assets; endorsed by the Group of Governors and Heads of Supervision. - Committee agreed to implement by January 1, 2025. - Proposal split crypto assets into two categories: lower-risk anchored crypto assets and higher-risk “traditional” crypto assets (like Bitcoin). The first category distinguished tokenized assets and stablecoins. - Credit and market risk capital requirements for tokenized assets would be similar to those of traditional assets. - For stablecoins, the proposal considered a possible lower risk weight based on certain conditions. - For traditional crypto assets (including unbacked crypto assets), BCBS proposed a conservative prudential treatment based on a 1250 percent risk weight to be applied to maximum long and short positions. - Committee on Payments and Market Infrastructures (CPMI): - In 2022, CPMI and IOSCO published guidance on application of the Principles for Financial Market Infrastructures (PFMI) to stablecoin arrangements (SAs). - The guidance defines the SA’s transfer function as the transfer of coins between users and typically entails the operation of a system, rules for transfer, and a mechanism for validating transactions (similar to other FMIs). - Guidance aims to clarify a subset of principles (governance; comprehensive risk management; settlement finality; money settlements); SAs expected to observe all relevant principles. - Further work expected on multicurrency SAs and stablecoins with non-cash reserve assets and on PFMI Responsibilities. - Financial Action Task Force (FATF): - In 2018 FATF defined virtual assets (VAs) and virtual assets service providers (VASPs); entire FATF standards apply to activities involving VAs. - 2018 and 2019 introduced provisions specific to VAs and VASPs, including FATF Glossary, Recommendation 15 on "New Technologies," and its Interpretive Note. - FATF issued an Updated Guidance for a Risk-Based Approach for Virtual Assets and Virtual Asset Service Providers. - Financial Stability Board (FSB): - October 2020: FSB published high-level recommendations to promote coordinated and effective regulation, supervision, and oversight of global stablecoin arrangements. - February 2022: FSB published an assessment of risks to financial stability posed by crypto assets; concluded crypto assets are not globally systemic but noted stablecoins may have potential to be systemic in the future. - October 2022: FSB revised high-level recommendations on global stablecoins to reflect new products and trends; consulted on high-level recommendations on regulation, supervision, and oversight of broader crypto asset activities and markets. - FSB recommendations do not address macro-financial considerations as set out in the Fund’s proposed elements of an Effective Policy Framework. - International Organization of Securities Commissions (IOSCO): - February 2020: IOSCO published final report on issues, risks, and regulatory considerations relating to crypto asset exchanges. - Regulatory framework elements for crypto asset platforms include: (i) governance requirements for platform operators, including prudential requirements; (ii) access requirements; (iii) robustness, resiliency, and integrity of operating systems; (iv) market integrity requirements; (v) transparency requirements; (vi) AML/CFT requirements; and (vii) criteria to accept products for platforms. - 2022: IOSCO published a fact-finding report on key risks and considerations on DeFi. ### Annex III — The FTX debacle: facts, impacts, and policy implications - Key facts and market impact: - FTX was once valued at $32 billion. - FTX filed for bankruptcy protection on November 11, 2022. - Price impacts: Bitcoin dropped 23 percent; Ether dropped 43 percent. - DeFi total value locked (TVL) dropped by around 17 percent to 45 billion. - Vulnerabilities highlighted: - Lack of basic information on crypto exchanges (corporate structure, financial information, composition of reserves including exposure to self-issued tokens) hampers assessment of interconnections and governance/risk robustness. - Opaque and significant intra-group transactions and interlinkages: - FTX reportedly lent more than half of its customer funds to its trading arm, Alameda Research. - Alameda Research held significant claims on FTX through holdings of the unbacked self-issued token, FTT. - Such interconnectedness points to severe governance and risk management failures and consumer protection concerns. - Integrated multiple functions (brokerage, trading, custody) often not subject to regulation and oversight: - Integration at FTX led to leveraged lending to consumers, liquidity mismatches, and inability to meet higher withdrawal demands. - Cross-jurisdictional domiciliation of providers and affiliates with different reporting requirements increases opacity and reduces transparency. - Policy responses and recommendations emphasized: - Strengthen transparent and robust governance and risk management frameworks. - Ensure segregation of customers’ assets. - Where trading, storage, and brokerage services are integrated, establish clear and distinct regulatory requirements for each activity. - Increase transparency and disclosure requirements. - Require independent third-party audits. *International Monetary Fund — Elements of Effective Policies for Crypto Assets (excerpts).* --- _Source: https://www.imf.org/-/media/files/publications/pp/2023/english/ppea2023004.pdf_