Why cryptocurrency boom is giving the jitters to financial regulators

Everyone wants to invest in cryptocurrency, for the future of money is electronic.

There is a whole new world of financial possibilities available for holders of digital currencies such as Bitcoin and Ethereum, including services such as lending and borrowing, and a decentralised financial ecosystem that is a foil to traditional financial infrastructure.

But there are risks in navigating the decentralised territory of crypto, as the latest Global Financial Stability Report of the International Monetary Fund (IMF) highlights.

The crypto ecosystem is flourishing with few checks and lacks strong operational, governance, and risk practices, and as digital assets become more mainstream, they will have implications for the wider economy and financial stability.

Note this: the total market value of all crypto assets surpassed $2 trillion as of September 2021 – a 10-fold increase since early 2020.

The IMF observes a few other things: Crypto exchanges facing disruptions during periods of market turbulence, cases of hacking-related thefts of customer funds, substantial consumer protection risks given limited or inadequate disclosure and oversight, and fears of money laundering and terrorist financing because of anonymity of crypto assets.

Making regulation difficult is the fact that the crypto ecosystem falls under different rules in different countries, and that people have just increased their trading volumes sharply in crypto exchanges in 2021.

Also read: Crypto Adoption: Volatility and ease of investing aided the rise of crypto in India

Stablecoins, a diverse group of crypto assets which aims to peg their value usually against the US dollar, are also catching on fast, with their supply climbing four-fold throughout 2021 to reach $120 billion, the IMF notes.

There are fears that “widespread and rapid adoption (of crypto assets) can pose significant challenges by reinforcing dollarisation forces in the economy – 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”.

Further, there is the added threat to fiscal policy “given the potential for crypto assets to facilitate tax evasion”.

So how do regulators address these concerns?

The IMF suggests that “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 prioritise strengthening macroeconomic policies and consider the benefits of issuing central bank digital currencies and improving payment systems”.

Other measures include rapid monitoring of happenings in the crypto ecosystem, addressing or closing of data gaps, enhanced international cooperation as well as implementation of existing global standards.

And all this has to be done fast, as crypto mania catches on.

Also read: India ranks second in terms of crypto adoption, behind Vietnam