Some Key Elements of Crypto Regulation
IMF News, December 9, 2022
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Bibliographic details
- Authors: Bo Li
- Published: December 9, 2022
Context and motivation
- Speech at Roundtable on Regulation and Supervision of Crypto Assets by Bo Li, IMF Deputy Managing Director, December 9, 2022.
- Timeliness illustrated by "severe turmoil and disruption in many parts of the crypto asset market recently" and "repeated cycles of rapid growth and retreat of the crypto ecosystem."
- Market failures cited: stablecoins, hedge funds and exchanges, raising concerns about market practices, client protection, interlinkages with the core financial system, systemic risk oversight and financial stability.
- Policy objective: strengthen financial regulation in this area and develop global standards that can be implemented consistently by national regulatory authorities.
Systemic risk assessment and specific concerns
- "Crypto assets, including stablecoins, are not globally systemic, but in some emerging market economies, they might be on the verge of generating risks to financial stability."
- Emerging market concerns:
- Large retail holdings and cryptoization, or currency substitution by crypto assets.
- Cryptoization can lead to capital outflows and a loss of monetary sovereignty, creating new challenges for policy makers.
- Authorities need to address the root causes of cryptoization to improve trust in domestic currencies, in domestic banking system, and in domestic economic policies.
- Advanced economy concerns:
- Institutional investors increasing stablecoin holdings, attracted by higher returns on DeFi platforms in what had been a low interest rate environment.
- Advanced economies "are also potentially susceptible to financial stability risks from crypto assets."
- Stablecoins:
- Defined as "a type of crypto asset that aspire to dampen their price volatility through various stabilization mechanisms, but there is no stablecoin in the market right now that can assure this under all circumstances."
- Some stablecoins are "starting to find acceptance outside the crypto space" and "have the potential of becoming widely used payment instruments," making them look more and more like "money."
- If not properly regulated, stablecoins "could pose serious challenges to monetary and financial stability."
Five key recommendations (as presented)
- First, "crypto asset service providers delivering critical functions should be licensed, registered, and authorized."
- Examples of such entities: those providing storage, transfer, exchange, settlement, and custody services.
- Rules should be similar to those applying to providers of these services in the traditional financial sector.
- Licensing and authorization criteria should be clearly articulated, the responsible authorities clearly designated, and coordination mechanisms among them well defined.
- Second, "entities carrying out several functions should be subject to additional prudential requirements."
- Lesson: "The recent FTX failure showed how the combination of exchange, wallets, and market making services under one group creates significant risks to the customers."
- Emphasis: customer assets should be segregated from other functions.
- Third, "stablecoins issuers should be subject to strict prudential requirements."
- Recommendation: "We need strong, bank-type regulation for stablecoins, and central banks should take the lead in such an endeavor given stablecoins’ potential presence in the monetary system."
- Fourth, "there should be clear requirements on regulated financial institutions, concerning their exposure to, and engagement with, crypto."
- If regulated entities provide custody services, requirements should be clarified to address the risks arising from those functions.
- Fifth, "and eventually, we need robust, globally consistent, comprehensive regulatory responses to achieve effective crypto regulation and supervision."
- Reason: "The cross-sector and cross-border nature of crypto assets limits the effectiveness of uncoordinated national approaches."
- Requirement for global approach: must be adaptable to a changing landscape and risk outlook.
Additional policy options and implementation notes
- Targeted restrictions may deliver better public policy outcomes provided there is sufficient regulatory capacity.
- Examples: restrict the use of certain crypto derivatives (as shown by Japan and the UK); restrict crypto promotions (a step taken in Spain and Singapore).
- Developing global standards takes time; recognition of the Financial Stability Board's contributions:
- The FSB has provided high-level recommendations for crypto assets and revised them for global stablecoins to close gaps in the market.
- IMF Fintech Notes draw many of the same conclusions, reflecting close collaboration and shared observations on the market.
- Balance emphasized: "move quickly to manage the risks that crypto assets generate, while not stifling innovation."
Closing
- The speech passes to Tobias Adrian, Financial Counsellor and Director of the Monetary and Capital Markets Department, to moderate the dialogue and solicit views on these critical issues.
Source: "Some Key Elements of Crypto Regulation" — By Bo Li, IMF Deputy Managing Director, Roundtable on Regulation and Supervision of Crypto Assets, December 9, 2022.