How Crypto Assets Can Threaten the Global Financial System

Today, I want to talk about a very interesting and timely paper that was published by the International Monetary Fund (IMF) titled “Assessing Macrofinancial Risks from Crypto Assets” and it explores how crypto assets, such as Bitcoin, Ethereum, or stablecoins, can affect the stability and performance of the global financial system and the economy.

What is a Crypto Asset?

You might be wondering what crypto assets are and why they matter. Crypto assets are digital tokens that are created and exchanged using cryptography and distributed ledger technology (DLT). They can have different functions, such as serving as a medium of exchange, a store of value, or a unit of account. Some of them, like Bitcoin, are not backed by anything and their value depends on supply and demand. Others, like stablecoins, are backed by real assets or algorithms and aim to maintain a stable value.

Crypto assets have been growing rapidly in popularity and size in recent years. According to the paper, the total market capitalization of crypto assets was about $US 1.2 trillion as of the end of April 2023, which is comparable to the size of some large economies¹. Crypto assets offer potential benefits, such as faster and cheaper payments, greater financial inclusion, and more innovation. However, they also pose significant risks, such as volatility, fraud, cyberattacks, regulatory uncertainty, and spillovers to the rest of the financial system and the economy.

Framework to assess risks and implications for financial stability

The paper proposes a framework and a tool to assess these risks and their implications for macro-financial stability. The framework consists of three steps:

• The first step is to use a decision tree to determine whether crypto assets are macro-critical in a country, meaning that they have a significant impact on the balance of payments or domestic stability. If crypto assets are used as legal tender or as private assets in an economically meaningful way, they should be covered in country monitoring.
• The second step is to use a country risk mapping to identify the main vulnerabilities, triggers, potential effects, and policy options related to crypto assets. The paper identifies seven groups of vulnerabilities:

1. systemic importance,
2. credit risk,
3. concentration risk,
4. liquidity risk,
5. market risk,
6. regulatory risk, and
7. operational risk.

For each vulnerability group, the paper suggests some indicators to measure the risk exposure level and possible triggers that could lead to systemic events.

• The third step is to consider the global macro-financial risks from crypto assets that could affect a country’s systemic risk assessment. These include risks from cross-border spillovers, contagion effects, currency substitution, monetary policy transmission, capital flow volatility, reserve adequacy, and international cooperation.

The paper also applies the framework to three country cases: El Salvador, Central African Republic (CAR), and Vietnam. These countries have different levels of crypto asset adoption and different policy challenges. For example:

• El Salvador adopted Bitcoin as a legal tender in September 2021, which could increase its exposure to crypto asset volatility and spillovers. The paper recommends narrowing the scope of the Bitcoin law to contain some of the macroeconomic risks and enforcing strict regulation and supervision to mitigate fiscal, financial integrity, and financial stability risks.
• CAR has launched a project called Sango to create a national digital currency based on DLT and backed by natural resources. This project poses multifaceted challenges for governance, financial integrity, consumer protection, infrastructure development, and legal framework. The paper advises creating the adequate prerequisites for such an ambitious initiative before proceeding with its implementation.
• Vietnam has a high level of crypto asset activity among individuals and businesses but lacks a clear legal and regulatory framework for crypto assets. The paper suggests developing a comprehensive strategy for crypto asset regulation and supervision that is consistent with international standards and best practices.

The paper concludes by highlighting some policy challenges and implications for dealing with crypto assets. These include:

• Enhancing data availability and transparency to monitor crypto-asset activity and risks
• Developing effective regulation and supervision that balances innovation and stability
• Strengthening cyber resilience and operational capacity to prevent and manage cyber incidents
• Coordinating policy responses across sectors and jurisdictions to address cross-border spillovers
• Promoting public awareness and education on the benefits and risks of crypto assets

I hope you enjoyed this blog post and learned something new about crypto assets and their macro-financial implications. If you want to read the full paper by the IMF authors Burcu Hacibedel and Hector Perez-Saiz , you can find it here. Here are some key takeaways from this post:

• Crypto assets are digital tokens that can have different functions and are created and exchanged using cryptography and DLT
• Crypto assets offer potential benefits but also pose significant risks for macro-financial stability
• The IMF paper proposes a framework and a tool to assess these risks in three steps: decision tree, country risk mapping, and global risk assessment
• The paper applies the framework to three country cases: El Salvador, CAR, and Vietnam
• The paper highlights some policy challenges and implications for dealing with crypto assets, such as data, regulation, cyber resilience, coordination, and education

Disclaimer: The views expressed in this blog are not necessarily those of the blog writer and his affiliations and are for informational purposes only.

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