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Increased 'Cryptoization' May Pose Challenges To Financial Stability: IMF

IMF in its Global Financial Stability Report 2021 pointed out that for emerging market and developing economies, adoption of cryptocurrency might be luring but they also come with a set of potential macro-financial risks, especially with respect to asset and currency substitution.

Increased 'Cryptoization'  May Pose Challenges To Financial Stability: IMF
Increased 'Cryptoization' May Pose Challenges To Financial Stability: IMF
outlookindia.com
2021-10-02T13:42:13+05:30

The International Monetary Fund said while the crypto ecosystem continues to grow, it poses serious challenges to a country's financial stability. It added that this could be particularly true for emerging markets and developing economies. 

India has seen a massive spurt in crypto users of late. The number of blockchain start-ups surpassed 300 in 2021, with the daily crypto trading volume peaking between $300 -$500 million. As per Global Consumer Survey in 2020, 99 per cent of its respondents responded that they did trade in cryptocurrencies. India ranks higher than China, United States, Germany and Japan in crypto adoption. Nigeria, Vietnam and Philippines topped the mentioned survey. 

"Challenges posed by the crypto ecosystem include operational and financial integrity risks from crypto asset providers, investor protection risks for crypto-assets and Defi, and inadequate reserves and disclosure for some stablecoins, " the report stated. 

IMF in its Global Financial Stability Report 2021 pointed out that for emerging market and developing economies, adoption of cryptocurrency might be luring but they also come with a set of potential macro-financial risks, especially with respect to asset and currency substitution. IMF referred to this phenomenon as 'cryptoization'. 

Cryptos rise amid sizeable bouts of price volatility

After recurrent fluctuations, the market value of crypto assets have increased again to more than $2 trillion at the time of publishing the report, IMF stated. This amounts to a year-to-date 170 per cent increase. 

"Despite significant price appreciation, the returns of non-stablecoin crypto assets are less impressive when adjusted for volatility. For example, the risk-adjusted returns of Bitcoin over the past year are similar to the performance of broader technology equities or the S&P 500," IMF pointed out. 

As per the report, Bitcoin remains the dominant Crypto asset. However, its market share fell sharply in 2021 from 70 per cent to less than 45 per cent. It said the interest has shifted towards newer blockchains that use smart contracts that replace the earlier ones by enhancing scalability, interoperability, and sustainability.

Stablecoin trading volumes have outpaced all other crypto assets. This is primarily because of their high usability for on-spot settlements and derivatives trades on exchanges. The relative price stability has shielded users from the volatility of other crypto assets. Further implying that users do not move their funds away from the crypto ecosystem. 

The crypto-ecosystem is free of intermediaries and match credit platforms match borrowers and lenders without any credit-risk evaluation. They operate directly on blockchains without any customer identification requirements. IMF said the deregulated finance made possible by the crypto ecosystem has particularly helped its popularity and intake. 

Why cryptos can be vulnerable?

IMF pointed out that cryptos are particularly vulnerable and are bundled with a set of operational, cyber and governance risks. 

Operational risks may potentially result in significant downtime when failures and disruptions would prevent the use of services. This could potentially lead to huge losses for the customer. High periods of transaction activity and poorly designed systems and controls make it particularly vulnerable to such risks. 

Cyber risks occur because such systems are prone to cyber-attacks.

Thirdly, governance risks because these platforms lack transparency pertaining to how cryptos are issued and distributed. This could again pave the way for huge losses.

Lacking an oversight mechanism, the ecosystem is vulnerable to consumer fraud and market integrity risk, IMF pointed out. It added that most crypto assets are highly volatile and speculative assets. The recent 'meme token' phenomenon is a point in case, most speculative assets and prices inflated by social media trends. 

"Monitoring the activity of crypto-asset service providers is complicated by limited, fragmented, and, in some cases, unreliable data. Public data sharing by crypto asset providers is currently mostly voluntary and lacking standardization," it stated. The crypto-asset providers moreover are often headquartered in jurisdictions with favourable regulatory, tax, and legal frameworks.

The macroeconomic challenges

There is no reliable method to estimate the stock or flow of crypto assets based on country residency, IMF stated. It added that a commonly used proxy is residency estimates based on internet visits to websites of crypto asset providers.

Unenthising macroeconomic policies and inefficient payment systems have been pivotal factors to spurt 'Cryptoization'.  Further, cryptos have helped domestic residents convert some of the headwinds of traditional dollarization into tailwinds. This leads to weaker central bank credibility and triggers an asset substitution. It could impede central banks' effective implementation of monetary policy and pave the way for currency mismatches. It could also lead to tax evasion. 

"Given the large share of unbanked people in some emerging market and developing economies, remittances often take place through cumbersome cash-based methods, such as those of post offices and other transfer operators. The payment rails of crypto assets can make some of these services faster and cheaper, especially through the integration of stablecoins, which allow for a stable unit of account, " the report stated. 

The way forward 

IMF suggests, " Enact de-dollarization policies, including enhancing monetary policy credibility; a sound fiscal position; effective legal and regulatory measures; and the implementation of central bank digital currencies." 

It added that prioritizing the adoption of global standards and deeper regulations in areas of systematic importance would help in easing out pressures. 

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