Crypto Boom Poses New Challenges to Financial Stability
IMF Blog, October 1, 2021
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- Authors: Dimitris Drakopoulos, Fabio Natalucci, Evan Papageorgiou
- Published: October 1, 2021
Overview
- Crypto assets offer quick and easy payments, innovative financial services, and inclusive access to previously “unbanked” parts of the world.
- Along with opportunities come challenges and risks described in the latest Global Financial Stability Report, which offers policy options to navigate this uncharted territory.
The Crypto Ecosystem—What Is It, What’s at Risk?
- The total market value of all the crypto assets surpassed $2 trillion as of September 2021—a 10-fold increase since early 2020.
- The ecosystem includes exchanges, wallets, miners, and stablecoin issuers; many entities lack strong operational, governance, and risk practices.
- Crypto exchanges have faced significant disruptions during periods of market turbulence; there have been several high-profile hacking-related thefts of customer funds.
- So far, these incidents have not had a significant impact on financial stability, but the potential implications for the wider economy increase as crypto assets become more mainstream.
- Consumer protection risks remain substantial given limited or inadequate disclosure and oversight:
- More than 16,000 tokens have been listed in various exchanges and around 9,000 exist today, while the rest have disappeared in some form.
- Many tokens have no volumes or the developers have walked away from the project; some were likely created solely for speculation purposes or even outright fraud.
- The (pseudo) anonymity of crypto assets creates data gaps for regulators and can open doors for money laundering and terrorist financing; authorities may be able to trace illicit transactions but may not be able to identify the parties.
- The crypto ecosystem falls under different regulatory frameworks in different countries, complicating coordination; most transactions on crypto exchanges happen through entities that operate primarily in offshore financial centers, making supervision and enforcement challenging without international collaboration.
- Stablecoins:
- Supply climbed 4-fold throughout 2021 to reach $120 billion.
- The term “stablecoin” captures a very diverse group of crypto assets and can be misleading.
- Given the composition of their reserves, some stablecoins could be subject to runs driven by investor concerns about the quality of reserves or the speed at which reserves can be liquidated to meet potential redemptions, with knock-on effects to the financial system.
Significant challenges ahead
- Adoption measurement is difficult, but surveys and other measures suggest that emerging market and developing economies may be leading the way; residents in these countries increased their trading volumes in crypto exchanges sharply in 2021.
- Widespread and rapid adoption can pose significant challenges by reinforcing dollarization forces—or in this case “cryptoization”—where residents start using crypto assets instead of the local currency:
- Cryptoization can reduce the ability of central banks to effectively implement monetary policy.
- It can create financial stability risks through funding and solvency risks arising from currency mismatches.
- It can amplify risks to consumer protection and financial integrity.
- Threats to fiscal policy may intensify given the potential for crypto assets to facilitate tax evasion; seigniorage may decline.
- Increased demand for crypto assets could facilitate capital outflows that impact the foreign exchange market.
- Migration of crypto “mining” activity out of China to other emerging market and developing economies can impact domestic energy use—especially in countries that rely on more CO2-intensive forms of energy, as well as those that subsidize energy costs—given the large amount of energy needed for mining activities.
Policy action
- Regulators and supervisors need to monitor rapid developments in the crypto ecosystem and the risks they create by swiftly tackling data gaps.
- Enhance cross-border coordination to minimize regulatory arbitrage and ensure effective supervision and enforcement due to the global nature of crypto assets.
- National regulators should prioritize the implementation of existing global standards:
- Current standards focused on crypto assets are mostly limited to money laundering and proposals on bank exposures.
- Other international standards—in areas such as securities regulation, as well as payments, clearing and settlements—may also be applicable and need attention.
- As the role of stablecoins grows, regulations should be proportionate to the risks they pose and the economic functions they serve; rules should be aligned with entities that provide similar products (e.g., bank deposits or money market funds).
- In some emerging markets and developing economies, cryptoization can be driven by weak central bank credibility, vulnerable banking systems, inefficiencies in payment systems, and limited access to financial services:
- Authorities should prioritize strengthening macroeconomic policies.
- Authorities should consider the benefits of issuing central bank digital currencies and improving payment systems; central bank digital currencies may help reduce cryptoization pressures if they help satisfy a need for better payment technologies.
- Globally, policymakers should prioritize making cross-border payments faster, cheaper, more transparent and inclusive through the G20 Cross Border Payments Roadmap.
- Time is of the essence: action needs to be decisive, swift and well-coordinated globally to allow benefits to flow while addressing vulnerabilities.
Source: Crypto Boom Poses New Challenges to Financial Stability (IMF blog, October 1, 2021)