Warning from Central Banks: Crypto Exacerbates Financial Risks in Emerging Markets

Warning from Central Banks: Crypto Exacerbates Financial Risks in Emerging Markets

Cryptocurrency assets have posed a challenge to financial stability in developing economies, leading prominent central banks to emphasize the necessity of regulating them just like traditional assets. The Bank for International Settlements (BIS) highlighted that innovative solutions for payment issues should not be immediately labeled as “dangerous” due to their distinctiveness. Yet, the BIS conveyed a sense of skepticism regarding the allure of cryptocurrencies, terming it “illusionary,” within a comprehensive paper regarding regulatory strategies.

The Consultative Group of Directors of Financial Stability, a body comprising representatives from several central banks including those of the US, Argentina, Brazil, Canada, Chile, and Mexico, affirmed that cryptocurrencies had initially been presented as a remedy for high inflation and currency volatility in less developed economies. However, contrary to these claims, crypto assets have actually amplified financial risks in these economies rather than mitigating them. This has led the group to advocate for a thorough risk and regulatory assessment of cryptocurrencies, placing them on par with other conventional assets.

International organizations such as the International Monetary Fund (IMF) and the Bank for International Settlements have been closely monitoring the evolving stability risks originating from the expanding cryptocurrency market. The market’s meteoric rise, peaking at a value of $2.9 trillion in November 2021, raised concerns. Although the subsequent drastic decline in crypto’s value by 75% within a little over a year somewhat reassured regulators about its limited impact on the broader financial system, entities like the European Central Bank have persisted in warning about potential future risks. Additionally, the International Organization of Securities Commissions (Iosco) has been urging national authorities to adopt a swifter and more resolute approach.

Most of the top 20 countries with the highest crypto adoption rates are emerging markets. Notable examples include Venezuela, El Salvador, and Nigeria, where cryptocurrencies have been tested as potential solutions for economies plagued by inflation and depreciating national currencies. Despite this, the consortium of central banks expressed concerns that in these markets, crypto assets could exacerbate financial stability risks due to weakened legal frameworks, which might undermine contract enforcement and introduce inconsistency in enforcement practices.

Furthermore, the committee pointed out the convergence of limited financial literacy and technological awareness in emerging markets. This convergence, they argued, could significantly intensify risks to financial stability, particularly with regard to crypto assets. Looking beyond these markets, the BIS consortium underscored the increasing importance of a risk-based approach to crypto regulation. This is particularly pertinent if cryptocurrencies gain broader acceptance among retail investors and if their integration with the traditional financial system deepens.

In the United Kingdom, the ownership of cryptocurrencies doubled in the preceding year, according to the Financial Conduct Authority’s report in June. By 2022, approximately one in ten individuals in the UK possessed some form of cryptocurrency. Meanwhile, data from the Pew Research Center indicated that around 17% of Americans had invested in or traded cryptocurrency, a figure that remained relatively consistent from 2021 to 2022.

In summary, the concern regarding the impact of cryptocurrencies on financial stability in developing economies has prompted significant central banks to advocate for the regulation of these assets in line with conventional assets. Despite the initial promise of cryptocurrencies as a solution to economic challenges, the amplification of financial risks has led to a call for careful assessment and regulation. The continued growth of the cryptocurrency market demands a risk-based approach to regulation, especially if these assets become more intertwined with the traditional financial system.

Oliver Harris