Why Is the IMF Warning Against the Risks of “Cryptoisation”? (#96 - 2 May 2022)

Dear Friends, 

The IMF recently released a report warning of the growing risks of cryptoisation around the world, particularly in emerging market economies.

What does this mean? And how could it impact the future of not only crypto, but the future of money more broadly? We discuss this in detail below.

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Here we go!

The IMF recently released a report warning about the risk of cryptoisation in emerging markets where residents are opting to use crypto assets instead of their local currency.

Crypto asset trading volumes against some emerging market currencies have notably increased since the start of the pandemic.

Although a large part of this increase is due to speculative investment activities by emerging market residents, a more structural shift toward crypto assets as a means of payment and/or store of value is taking place, which could pose significant challenges to policymakers moving forward.

For instance, Tether—the largest USD stablecoin in the market today—has seen a notable rise in trading volumes against emerging market currencies. 

A prime example is Turkey, where the overall use of crypto assets appears to have gained traction over the last few months.

One very simple reason for this is the country’s rampant inflation and the desire of the Turkish people to have their assets in a more reliable store of value. For example, Turkey’s annual inflation rate rose to almost 70% this month and the outlook doesn’t look promising.

Crypto adoption has taken off so quickly in Turkey that the country has become a key market for many crypto firms.

For example, crypto exchange Binance even set-up a 24/7 customer support team in Turkey and it was reported that around 7% of those accessing the Binance website are doing so from Turkey (a percentage that is likely higher considering that many crypto users in such markets use VPNs).

For example, this graph shows the trading volumes of Tether in Turkey compared to certain emerging market currencies.

This is a phenomenon we are observing in many other countries as well.

More recently, trading volumes spiked following the introduction of sanctions against Russia and the implementation of capital restrictions in Russia and Ukraine.

The risk of cryptoisation is most relevant for emerging markets where inflation or hyperinflation is a problem.

What is happening in Turkey is a great example. And there is no shortage of other examples, from Argentina to Lebanon. 

In such countries, many high-value goods, from automobiles to real estate, are already denominated in dollars. Such transactions are often conducted in cash or via complicated banking transactions.

USD stablecoins allow people to not only ditch their local currencies for the U.S. Dollar but also the ability for them to use them on a regular basis with great ease, from savings and investments to payments and remittances.

Whilst the risk of dollarisation in emerging markets is one that is well documented and known by policy makers for a long time, the rise of stablecoins and crypto can really accelerate this. Cryptoisation is like dollarisation but on steroids.

Such a risk has been discussed many times in the past.

For example, when Facebook launched Libra, it explicitly warned that stablecoins may lead to the dollarisation of economies and, at the time, had even invited central banks to join the Libra platform. 

Central banks are fully aware of this risk.

It is not a surprise that following the announcement of Libra in 2019, central banks quickly started looking into CBDCs.

Whilst central bankers are worried about the rise of Bitcoin, they know that Bitcoin, similar to gold, will not be able to replace day to day payments.

Stablecoins on the other hand are different and can be a real threat.

To deal with the risks of cryptoisation, the IMF suggests a number of actions.

First, the IMF believes that policymakers around the globe should adopt a multipronged strategy to maintain and enhance the effectiveness of capital flow strategies, especially as crypto assets begin to be used more heavily. Such an approach would require clear and coordinated regulatory frameworks across jurisdictions whilst applying new guidelines to capital flow standards, with the IMF suggesting that international bodies adopt a collaborative approach before implementing any new policies. 

Whilst this is a great idea, we all know that any global coordination, especially on such matters as capital flows, takes years, if not decades. Crypto moves significantly faster so such an approach is unlikely to prevail in the short or medium term.

Second, the IMF stresses that the existing Financial Action Task Force (FATF) standards need to play an important role with regards to monitoring illicit crypto transactions. 

Once again, this suggestion is unlikely to work. The reality is that today most of the large crypto platforms are already compliant with the various FATF requirements. So trying to use the FATF to block the rise of crypto under the excuse that it is being used for illicit transactions will not necessarily work either.

And lastly, the IMF recommends that existing regulations for foreign exchange and capital flow management should be expanded to incorporate crypto assets.

Whilst great in theory, there are a number of challenges here too. Whilst some policy makers will be comfortable with giving such a status to crypto, this will be more challenging for many jurisdictions that either have tried to ban crypto or don’t recognize the asset class. But more importantly, it is not possible to stop individuals from conducting cross border transfers using stable coins. Unlike the traditional banking system, anyone with crypto assets can send them to someone else globally without the need of any intermediary.

In short, there is a real risk of cryptoisation for central banks, especially with regards to stable coins. The best thing that central banks can do is not to try to stop stable coins but rather to come up with sound policies that do not lead to hyper inflationary events and provide trust to the public.

Crypto assets and stable coins give people an alternative and a choice. And we should let people vote with their wallets.

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*Please note that this newsletter reflects Henri’s personal views and not those of any organisation he is involved with. This newsletter is for educational purposes only and none of its content should be construed as investment or financial advice of any kind.