The International Monetary Fund (IMF) calls for “comprehensive, consistent and coordinated” global crypto regulation. This is intended to protect the established financial system from crypto. The risks are enormous, especially in developing and emerging countries.
“Crypto assets” and the associated products and services are, the IMF introduces in a new post , “have grown rapidly in recent years.” But not only that: “The dovetailing with the regulated financial system” is also growing. It is getting closer and closer.
And so begins the problem to which the IMF and other international organizations are increasingly paying attention: crypto is eating its way into finance. Basically, that was to be expected. Where else should the reinvention of money begin if not in finance?
But upheavals are threatening, especially from the point of view of actors in the established system, and especially when the upheaval is not only technical, but also social and fundamental. The post through which the IMF is expressing its concern and suggesting measures to tame crypto is interesting in so many ways that it’s worth working through bit by bit.
Risks that are difficult to keep track of
From the point of view of the IMF, cryptocurrencies are a potentially large problem that is difficult to understand in detail. To determine the size of the market, the IMF relies on the (highly controversial) digit of the market capitalization of all cryptocurrencies. This amounts to 2.5 trillion dollars, which is certainly also based on the underlying technical innovations, such as the blockchain. But the number “possibly also reflects an environment of somewhat overstretched evaluations”.
That is nicely worded. If a muscle is stretched too far, it will tremble. The IMF observed the same thing in the crypto markets: When the first news of the Corona variant Omikron was circulating, the crypto prices plummeted promptly. This volatility can not only cause shocks to parts of the financial system. In some countries, the institution warns, “these financial stability risks may even soon become systematic.”
I assume the IMF is alluding to El Salvador, and possibly also to other countries that are flirting with how to make Bitcoin or stablecoins their national currency.
That the 2.5 trillion dollars is a rather uncertain value that exists or does not exist, like Schrödinger’s cat, and that tomorrow no longer has to be what it is today, and that with its fluctuations can shake entire economies overnight – that is just one of the challenges crypto poses to the IMF and the world’s rulers. “The identification, monitoring and management of risks” alone defies the efforts of regulators and companies.
Most legislators would find it difficult to “oversee the risks that arise from this area, in which many activities are still unregulated.”
When the Bitcoiners’ dreams turn out to be a nightmare at the IMF
What are the risks? The IMF sees, among other things, internal risks, i.e. risks that arise in the crypto-economy and are initially limited to these: “Operational and financial integrity risks from crypto exchanges and wallets, risks of investor protection, inadequate reserves and inaccurate disclosures through stablecoins. ”Here, too, the allusion can hardly be overheard, this time to the stablecoin tether (USDT).
Such internal risks particularly affect investors who usually knew what they were doing and who have usually already benefited from the crypto boom. The IMF analysts do not have to be ripped off about their damage.
But it becomes more worrying when the risks jump out of the crypto ecosystem. On the one hand, the IMF worries that internal shocks in the crypto industry are spreading across general finance. This fear that a crypto crash will become the next Lehmann event that will trigger a global financial crisis has become more prevalent in recent months, for example at the British central bank.
In addition, the IMF is worried about another concern: In developing and emerging markets – hello again, El Salvador – the emergence of crypto could “accelerate what we call ‘cryptoization’ – if these assets displace the domestic currency and exchange restrictions and measures undermine capital control. ”
At this moment we have to stop for a moment. The IMF is taking on a meme from the Bitcoin and crypto scene. Bitcoiners have long been talking about “hyper bitcoinization”, the displacement of established currencies by Bitcoin. The meme goes back to an article that Daniel Krawisz wrote for the Nakamoto Institute in 2014. In it he explains how Bitcoin initiates a “demonetization”, “which seizes every helpless currency that stands in the way of Bitcoin’s course for total world domination. When that happens, the currency will rapidly depreciate and Bitcoin will replace it. ”
The Ethereum scene, on the other hand, likes to speak of ” tokenization “: of the mapping of everything (and everyone?) As tokens. “The tokenization of everything will create new markets, fill the existing markets with liquidity, and break the silo architecture of current ecosystems and replace them with the fundamental interoperability of blockchains.”
When the IMF now writes about “cryptoization”, it is blowing exactly the same horn: it is confirming the strongest visions of the crypto scene, which, however, are now being hit by the international body as nightmares. That’s a pretty interesting development. You could also call it “victory”.
Wrong regulation threatens to destabilize global capital flows
The IMF recognizes that regulating cryptocurrencies is not that easy. National solo efforts gritted their teeth at the cross-sectoral and borderless nature of crypto. When different countries adopt different strategies, there are many opportunities for “regulatory arbitrage”: crypto companies settle somewhere with a mailbox and friendly laws. Online-only digital companies like crypto exchanges can choose where to set up shop.
In addition, crypto does not always fit into the regulatory status quo: “Existing laws and regulations sometimes do not allow all elements of these assets to be comprehensively covered as part of a national approach.” Here, too, the IMF remains abstract, but one could assume that it alludes to utility tokens, for example. In fact, these types of tokens often function like a security, such as a share, but are unregulated in many jurisdictions because they are not marketed as an investment but as a kind of tool.
In addition, the cross-border nature of crypto companies makes both monitoring and rule enforcement difficult. Many stock exchanges, for example, only exist physically as a letterbox company in some tax and regulatory haven, while employees, from support to management, log in digitally from anywhere. In the crypto world, as a digital nomad, you can run an exchange out of nowhere that generates more sales than, for example, the Stuttgart Stock Exchange.
The IMF fears that uncoordinated regulation in this environment threatens to destabilize global capital flows. Once again it is clear what dimension crypto has reached.
Proper regulation in the eyes of the IMF
Regulation of crypto can only be successful if it sets “comprehensive international standards”. Only these can protect the financial system from crypto, from the associated ecosystem and from the transactions associated with it. It is remarkable that the global financial system now needs protection from crypto, at least from the perspective of the IMF.
However, the IMF does not fail to recognize that there is an innovative technology in crypto. He therefore calls for regulation to preserve an “environment for useful crypto products and applications”. Which applications he means is unclear. Maybe all closed, centralized, blockchain-based currencies like China’s digital yuan.
The IMF does not feel called to take regulatory action. Instead, he calls on the Financial Stability Board (FSB) to develop “a global framework that contains standards for the regulation of crypto assets”. Ideally, it would offer “a comprehensive and coordinated approach that consistently crosses jurisdictions and minimizes the risk of regulatory arbitrage.” So there should be as few loopholes as possible.
In addition, the IMF has a number of suggestions as to what this framework should specifically contain. “Crypto service providers who fulfill essential functions are to be licensed or authorized.” These functions include, among other things, “the storage, transfer, settlement and fiduciary custody of reserves and assets.”
Service providers who do this are usually already strictly regulated. However, the separate mention of “fiduciary custody” may indicate that the IMF also wants non-fiduciary wallets to be regulated. On the other hand, he does not seem to have decentralized finance (DeFi) on his screen, which is why the “comprehensive” regulation may fail at the planning stage.
Furthermore, the requirements should be adapted to the primary use of crypto assets or stablecoins: services and products for investors should be “subject to similar requirements as stock brokers”, while payment service providers such as banks should be regulated. In itself, this is a good idea to untangle the clutter of rules and regulators that the industry often suffers from.
Finally, the authorities should formulate clear requirements on how regulated financial institutions can handle crypto. On the one hand, this seems to express the hope that a kind of takeover by established financial institutions will subdue the crypto markets, on the other hand, also the fear that uncontrolled “cryptoization” of the financial system will result in global upheavals.