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The fears of IMF with adoption of cryptocurrencies

 john Kreativ |
Finance & Investing

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The International Monetary Fund (IMF) on Thursday, 23rd February said that there is a growing adaptation of crypto usage and it warranted a “coordinated response”. They opined that crypto has tremendous potential benefits that would improve efficiency, spur private sector innovation, propel rapid financial inclusion and transparency, however, the widespread adoption of crypto assets has the propensity to undermine the effectiveness of monetary policy, circumvent capital flow management measures and contagion effect of worsening fiscal risks.

The market capitalization of crypto has been volatile, and their inter-connectedness with the financial sector has increased. Amid the decline in crypto asset valuations, the failure of various exchanges (such as FTX) and other actors within the crypto ecosystem will require effective policies towards the protection of the financial system.

Does the existence and usage of crypto assets really pose as an existential threat to the mandate of the IMF? In this blog post, we will find out the 9 policy deliberations that was discussed and How the widespread adoption of crypto assets pose a threat to the IMFs mandate.

Quick Overview

IMFs Purpose

The IMF and the World Bank were established in July 1944 at an international conference in the United States (in Bretton Woods, New Hampshire) after the aftermath of the Great Depression of the 1930s. 44 founding member countries sought to establish a framework for international economic cooperation aimed at creating a more stable and prosperous global economy. Today, its membership count embraces 190 countries.

At the top of its governance is the Board of Governors. The day-to-day work of the IMF is overseen by its 24-member Executive Board, represents the entire membership and supported by IMF staff, with the Managing Director heading the IMF staff and also as Chair of the Executive Board.

The IMF's resources mainly come from funds contributed by member countries as capital subscription (quotas). Each member of the IMF is assigned a quota, the quota contribution of members is based on their relative position in the world economy. Member Countries are able borrow or draw from this pool when they fall into financial difficulty.

The 9 Policy deliberations of IMF

The Executive Board of the International Monetary Fund (IMF) discussed a board paper on Elements of Effective Policies for Crypto Assets that provides guidance to IMF member countries on key elements of an appropriate policy response to crypto assets.

The policy deliberations set forth a framework of nine (9) elements to help member countries develop a comprehensive, consistent, and coordinated policy response.

#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.

The Directors of the IMF or Directors emphasized that robust macroeconomic policies, including credible institutions and monetary policy frameworks are first-order requirements and that Fund advice in these areas will remain crucial.

Also, Directors generally agreed that crypto assets should not be granted official currency or legal tender status in order to safeguard monetary sovereignty and stability. Fiscal risks posed by crypto assets including contingent liabilities to the government should be fully disclosed as part of countries’ fiscal risk statement.

Directors were in agreement that strict bans are not the first-best option, and that targeted restrictions could apply, depending on domestic policy objectives.

Directors also cautioned that in implementing these, regulators should be mindful not to stifle innovation, and the public sector could leverage some of the underlying technologies of crypto assets for their public policy objectives.

How adoption of crypto could pose a threat to IMF

The IMF's primary purpose is to ensure the stability of the international monetary system by monitoring exchange rates and enabling countries to transact with one another, as a result, any event that could undermine the promulgation of their function is considered as a threat.

Herein are reasons why crypto is considered a threat to financial stability -IMF:
#0. Speculative attack on nations : A speculative attack normally occur with countries that use a fixed exchange rate system, here, the price of a currency may be fixed in relation to fiat, dollar or other reserve currency, investors who want to carry out this exploit can borrow a large amount of a target nations currency and convert it into crypto or a foreign currency. The massive outflow of the target nations currency, forces the nation to abandon the fixed rate and starts to fluctuate, this sends a signal to the market that the native currency is loosing value.

In the event that a wealthy Bitcoin investor launches a speculative attack on a currency, countries will have to purchase bitcoin to offset the attack. Where a countries Central Bank are unable to meet the reserve required. They will have to turn to the IMF, the IMF also does not keep bitcoin reserves and neither is it permitted to use any fund to purchase any asset. As a result, the IMF would be unable to supply the crypto currency needed to off-set the destabilizing effect of a speculative attack by a Bitcoin attacker on a member nation's currency.

#1. Threaten the effectiveness of monetary policy among nations : The implementation of monetary policy would weaken among nations if firms and households develop a preference to save and hold unpegged crypto as opposed to their domestic fiat. The risk of currency substitution will be profound for countries with unstable currencies and weak monetary frameworks. Also, the decentralized and anonymity features of certain crypto assets, makes their regulation challenging, ease their accessibility and their potential use for circumventing existing capital control measures.

#2. Impact on capital flows’ volume and volatility : Usage of crypto in cross-border transactions is far less costly than existing asset classes, this may create additional incentives for investors to allocate capital across borders. Gross capital flows could increase as a result, as could capital flow volatility, given the large price volatility of unbacked crypto tokens and the potential for herding behavior by investors across borders.

#3. Eroding the effectiveness of capital flow measures (CFMs), and limit to countries’ ability to counteract capital flow volatility : Crypto assets are not covered by existing CFM laws and regulations, as a result, authorities may not have a mandate and powers to control their use. Secondly, the pseudonymous nature of transactions will make prosecution and sanctioning extremely difficult.

#4. A potential to undermine the effectiveness of the international monetary system : Crypto assets, have been mostly held for price speculation, with only limited use as a medium of exchange. Despite this, strong correlations exist between payment currency and reserve currency suggests that the adoption of crypto for payment purposes might eventually lead to a demand for crypto asset reserves.

#5. Potential to increase fiscal risks for public finances : New fiscal risks can arise from the financial sector’s exposure to the crypto assets due to the fact that crypto co-exists with the financial system, lack of clarity of tax regimes, weak or no regulation and the extra-territorial nature of crypto assets.

#6. Effect on monetary stability and legal issues : If a crypto asset is granted a legal tender status, creditors would be required to accept it in payment of monetary obligations, including taxes, similar to notes and coins (currency) issued by the central banks. Households and businesses would spend significant time and resources in deciding which asset to hold as money as opposed to engaging in productive activities. Consequently, domestic prices and imports could become unstable due to the market volatility. Also, usage will not be possible where internet access is not available.

#7. Amplify fiscal risks when granted a legal tender status : If a crypto asset is not pegged to the domestic fiat currency, or whose peg may not be sustainable, is adopted as an official currency or granted legal tender status, government revenues may be exposed to exchange rate risks, tax or non-tax revenues will be quoted in advance in a crypto while expenditures will be made primarily in the local currency.

#8. Due to their pseudonymous nature, crypto assets can be attractive to criminals, raising financial integrity risks : Although in most decentralized ledger technology (DLT) networks transactions are public and therefore visible, linking an address or wallet to an individual can be challenging. In traditional finance settings Customer due diligence measures are put in place and that even serves as a deterrent. The usage of crypto is significantly and positively associated with higher perceptions of corruption (Alnasaa et al. (2022).

#9. Crypto assets are also prone to manipulation and therefore to fraud and market integrity risks : In permission-less decentralized ledger technology (DLT), users can set the fees of their own transactions to rank higher or lower in the settlement queue and obtain financial gains by paying more for transaction cost. Also, Large validators or miners could congest the blockchain with artificial trades (Bains 2022), raising the fees that other users pay. Moreover, illiquidity of certain exchanges or crypto assets may facilitate crypto asset price manipulations - to trigger liquidations and purchase liquidated collateral at a discounted price or short the collateral asset (Werner et al. 2021).

#10. Consumer protection risks : Risks to consumers stem from inadequate governance, opaque decision-making processes, and limited recourse when there is insufficient regulation. Consumer protection risks may also arise from price volatility, fraud, or cyber-attacks. In November, 2022, FTX filed for bankruptcy protection revelations showed risky investments, inadequate governance, and opaque corporate interlinkages. The run on FTX exerted significant spillovers on major crypto assets and also impacted decentralized finance and stable coin markets, ultimately impacting investors.

#11. The network’s open architecture could be a source of significant cyber risks : Tech savvy individuals can create open applications not subjected to code audit. Users have financial incentives to take advantage of these bugs at the expense of others rather than report them. Also, self-custody wallets (wallets with keys kept by users) creates additional risk of loss of funds when password is lost. And there is no recourse to recover.

#12. Fraud, Corruption, Tax evasion and related Money laundering effects : Considering the fact that crypto currencies are unregulated, it serves as an avenue for committing illegality and moving financial resources earned from theft, corruption and drug trafficking from one country to another with no detection, thereby undermining any regulatory responses especially among its member countries and threatening the soundness and stability of financial institutions and capital flows.

The IMF works closely with other organizations like the World Bank, the United Nations, and FATF. The IMF and World Bank, the FATF monitors countries’ compliance with these recommendations.

U.S Treasury risk assessment of Crypto

on 6th April, 2023, the U.S. Department of the Treasury published the 2023 DeFi Illicit Finance Risk Assessment, the first illicit finance risk assessment conducted on decentralized finance (DeFi) in the world. The assessment considers risks associated with what are commonly called DeFi services. DeFi services refers to the decentralization of the participation in the financial intermediation functions in the economy. DeFi mostly grant loans, creates privately issued money which is unregulated and also offer means of transfer of money discretely without oversight.

The assessment revealed that illicit actors, including criminals, scammers, cyber actors are using DeFi services in the process of laundering illicit funds. Risk assessments are done to identify the scope of an issue, and also provide recommendations for U.S. government actions and policy makers to mitigate the illicit finance risks associated with DeFi services by strengthening U.S. AML/CFT regulatory supervision; providing additional guidance for the private sector on DeFi services’ and their obligations towards AML/CFT.

Finally
Having shared with you the motivations, mandate and policy deliberations. Can the widespread adoption of crypto pose a threat to International bodies or even de-throne the dominance of the dollar as the reserve currency held by many?, actions and events will unfold how acceptance is earned.



Reference : IMF, Elements of Effective Policies for Crypto Assets

Plassaras, Nicholas A. (2013) "Regulating Digital Currencies: Bringing Bitcoin within the Reach of the IMF," Chicago Journal of International Law: Vol. 14: No. 1, Article 12




Disclaimer:
The views and opinions expressed by the author, or any people mentioned in this article, are for informational purposes only, and they do not constitute financial, investment, or other advice. Investing in or trading crypto assets comes with a risk of financial loss.

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