Type to search

‘Cryptoization’ of Emerging Markets Threatens Financial Stability, IMF Says

The IMF says the market value of crypto assets surged 10-fold since early 2020 to surpass $2 trillion and warns that increased trading of the assets risks triggering destabilizing capital flows.

The rapid growth of digital currencies in emerging markets may fuel the “cryptoization” of local economies, potentially circumventing exchange and capital controls and threatening financial stability, the International Monetary Fund said.

Unsound macroeconomic policies and inefficient payment systems are among the drivers of cryptocurrency adoption in emerging economies, along with the lure of quick gains, it said in a blog post on Friday. The total market value of all crypto assets surpassed $2 trillion as of September 2021—a 10-fold increase since early 2020, it said.  An entire ecosystem is also flourishing, replete with exchanges, wallets, miners, and stablecoin issuers,” it added.

“In emerging markets, the advent of crypto assets has benefits but can accelerate cryptoization and circumvent exchange and capital control restrictions,” the IMF said. “Increased trading of crypto assets in these economies could lead to destabilizing capital flows.”

Many crypto entities lack strong operational, governance, and risk practices, the IMF said. Crypto exchanges have faced significant disruptions during periods of market turbulence and there are also high-profile cases of hacking-related thefts of customer funds, it added. While such incidents have not had a significant impact on financial stability so far, as crypto assets become more mainstream, their importance in terms of potential implications for the wider economy is set to increase, the IMF said.

Factors such as low credibility of central banks and weak domestic banking systems that can fuel “dollarization” can also contribute to growing crypto use, the blog post added. Dollarization is where a foreign currency – typically the U.S. currency – is used in addition to, or instead of, a domestic currency. High inflation or the instability of a domestic currency are among the drivers of the process.

Bitcoin and its kin have in the last year soared in price and popularity, with emerging and developing market economies such as Vietnam, India and Pakistan seeing rapid growth in some measures of adoption, according to U.S. blockchain researcher Chainalysis. Cryptocurrencies offer, in theory, a cheaper and quicker way of sending money across borders. Backers say digital tokens such as stablecoins could also help protect savings from high inflation or fluctuations in local currencies.

Legal Tender

In September, El Salvador became the first country in the world to adopt bitcoin as legal tender, with backers tipping the experiment to lower costs for billions of dollars of remittances sent to the Central American nation. But the IMF said the exact level of adoption of crypto in emerging economies was hard to gauge accurately.

Wide adoption of stablecoins – digital tokens designed to hold a steady value and seen as useful for savings and commerce – could also pose significant challenges by reinforcing existing dollarization forces, the IMF said.

“Dollarization can impede central banks’ effective implementation of monetary policy and lead to financial stability risks through currency mismatches on the balance sheets of banks, firms, and households,” it said.

“Cryptoization” could also become a threat to fiscal policy, with digital assets possibly facilitating tax evasion, the IMF added.

The fund urged developing nations to strengthen macroeconomic policies and consider the possible benefits from issuing central bank digital currencies as a response to the rise of crypto.

Kevin Hamlin and Reuters

ALSO ON AF: China’s Central Bank Says All Crypto Transactions Are Illegal

Kevin Hamlin

Kevin Hamlin is a financial journalist with more than 40 years of experience covering Asia. Before joining Asia Financial, Kevin worked for Bloomberg News, spending 12 years as Senior China Economy Reporter in Beijing. Prior to that, he was Asia Bureau Chief of Institutional Investor for ten years.

logo

AF China Bond