Recently, the International Monetary Fund (IMF) expressed its concerns as the trend of “cryptoization” gains momentum, with more individuals favoring cryptocurrencies like Bitcoin and stablecoins tied to the US dollar over traditional currencies.
This shift poses a threat to central banks and their monetary policies worldwide. In a September 2023 report with the Financial Stability Board, the IMF cautioned that the adoption of stablecoins could jeopardize the effectiveness of monetary policy and have significant implications for monetary stability.
The primary worry revolves around the potential displacement of domestic currencies by cryptocurrencies. If people opt for payments or transactions in Bitcoin or a dollar-pegged stablecoin instead of their local currency, they are essentially rejecting the currency issued by their own central bank. This rejection makes it challenging for central banks to wield influence over their economies through tools like interest rates and other monetary policies.
CCN addressed the issue of crypto adoption and its impact on traditional institutions with insights from Gracy Chen, the Managing Director at Bitget.
CCN: What drives cryptoization in emerging economies, and how does it impact their financial stability?
Chen: “Cryptocurrency has had its biggest impact on the quality of life in economically unstable regions or those with limited access to traditional banking. The decentralized and cross-border nature of cryptocurrencies makes information more transparent, thus increasing the level of financial education in these regions.”
“It is no wonder that striving for more financial inclusion and stability amidst economic unrest is the main driver of cryptoization in emerging economies. People in these regions may also invest in cryptocurrencies to potentially benefit from price increases, especially in situations where the local stock market is underdeveloped or difficult to access.”
“Of course, cryptocurrencies are known for their price volatility, which can be a double-edged sword. While they offer investment opportunities, they may also bring risks, especially if a significant number of people invest in cryptocurrencies without fully understanding the risks.”
CCN: How can authorities use monetary policy to combat the effects of cryptoization?
Chen: “The industry is regulated in a manner similar to traditional financial regulation. Here, however, we are dealing with a higher level of risk due to the underdeveloped state of financial regulation in emerging economies.”
“To address these risks, authorities can regulate the stablecoin systems and prohibit or restrict specific cryptocurrencies in violation of these policies. Most importantly, cryptocurrencies should be isolated from traditional finance and the real economy.”
“This is achieved by limiting the flow of funds in and out and by restricting the connection between the cryptocurrency market and traditional finance. It is the main approach adopted by emerging economies to prevent threats to traditional finance.”
CCN: What are the pros and cons of using dollar-pegged stablecoins as an alternative to native currencies?
Chen: “USDT transfers and clearing are more efficient, allowing for tamper-proof, peer-to-peer transactions and saving on bank fees. While it offers privacy, it still provides an effective regulatory avenue.
“However, it has been experiencing significant decoupling, reaching up to 98% on August 7th and more than 10% in March, meaning that USDT was trading at a discounted price on almost every trading platform.”
P”aired with the fact that the market cannot absorb large-scale USDT sales due to its redemption fees and minimum requirements, it may also mean that selling the token in the market is more favorable than converting Tether into US dollars.”
CCN: To what extent does cryptoization encourage a flight to the US dollar?
Chen: “When facing local currency devaluation and capital controls in some emerging market economies, the trading volume of stablecoins pegged to the US dollar has seen a sharp increase since 2020.”
“Particularly, when currencies like the Turkish lira and Brazilian Real experienced devaluation, their share in stablecoin trading was much higher than in traditional forex trading. The share of the Turkish lira in stablecoin trading increased from 0.3% in January to 11% in April at the beginning of 2020, and it continued to rise in 2021, reaching 26% in December, up from 11% in July.”
“Such a pattern could pose a threat to the financial stability and monetary sovereignty of emerging market economies.”
“The widespread adoption of stablecoins, digital tokens designed to maintain a stable value and considered beneficial for savings and commerce, may present substantial challenges by strengthening prevailing dollarization trends.”
“Dollarization has the potential to hinder the effective execution of monetary policy by central banks and introduce financial stability risks, particularly through currency mismatches on the balance sheets of banks, firms, and households.”
“Furthermore, there is a need to closely monitor whether cryptoization poses a threat to fiscal policy, as digital assets could potentially facilitate tax evasion.”