Business

The IMF Global Financial Stability Report sees complex roles for cryptocurrency DeFi

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According to the International Monetary Fund’s Global Financial Stability Report released on Tuesday, the war in Ukraine – in the immediate wake of the coronavirus pandemic – has caused global financial conditions to tighten. Rapid changes in fintech and the use and abuse of cryptocurrencies play a role in the jumble of challenges facing the global economy.

According to the report, the pandemic and war have prompted accelerated “cryptoization” in emerging markets due to heightened speculative interest during the pandemic and subsequent attempts to circumvent sanctions. Given the level of compliance within the crypto industry, using cryptocurrency to circumvent sanctions is impractical, according to the report. The use of mixers, decentralized exchanges, and privacy coins can allow some circumvention, but would be constrained by limited liquidity.

A related risk is the use of surplus energy by sanctioned countries – possibly built up as a result of sanctions – to mine proof-of-work cryptocurrencies, although financial flows from this activity would also be relatively limited. Countries concerned about falling under sanctions in the future may find crypto more attractive as a reserve currency — and major fiat currencies less so — thanks to the greater difficulty of immobilizing crypto.

All of these issues point to the need for a coordinated regulatory approach to crypto to maintain effective control over capital flows. Improving non-blockchain payment technologies would also help maintain this control.

The report also states that regulation is not keeping pace with rapid developments in many aspects of fintech. Decentralized finance, or DeFi, is becoming more associated with traditional finance due to its adoption by traditional financial institutions. DeFi’s lack of governance makes it a risk to financial stability and creates an environment of legal uncertainty. It is vulnerable to market, liquidity and cyber risks, but offers potential benefits through increased efficiencies and financial inclusion.

The IMF-recommended regulators focus on the elements of the crypto ecosystem surrounding DeFi, such as stablecoin issuers and centralized exchanges, and encourage the creation of self-regulatory bodies within the industry.