Financial stability risks from cryptoassets in emerging market economies

BISPapers No138 Financialstabilityrisksfromcryptoassetsinemergingmarketeconomies ConsultativeGroupofDirectorsofFinancialStability(CGDFS) August2023 JELclassification:E42,E58,G23,O31. Keywords:cryptoassets,stablecoins,financialstability,emergingmarkets. TheviewsexpressedarethoseoftheauthorsandnotnecessarilytheviewsoftheBIS. ThispublicationisavailableontheBISwebsite(www.bis.org). ©BankforInternationalSettlements2023.Allrightsreserved.Briefexcerptsmaybereproducedortranslatedprovidedthesourceisstated. ISSN1682-7651(online) ISBN978-92-9259-677-4(online) Tableofcontents Foreword1 Executivesummary2 1.Introduction3 2.Risksintraditionalfinancialmarketsandvulnerabilitiesincryptoassetmarkets7 2.1Marketrisk7 2.1.1Pricevolatility7 2.1.2Lackoftransparencyandaccountability8 2.1.3Recentdevelopments:BitcoinETFs.9 2.2Liquidityrisk10 2.2.1Centralisationandilliquidity10 2.2.2Scalabilitytrilemma11 2.2.3Recentdevelopments:mixed-collateralstablecoins11 2.3Creditrisk12 2.3.1Relatedpartytransactions12 2.3.2Lackofgovernanceanddisclosurerequirements12 2.3.3Leverageincryptoassetmarkets13 2.3.4Recentdevelopments:cryptoexchangeaccountsintraditionalfinancialinstitutions13 2.4Operationalrisk.14 2.4.1Technologicaldependencyandblockchaininfrastructure14 2.4.2Cybersecurityandcryptoassetserviceproviders14 2.4.1Recentdevelopments:cryptoexchangepilotintheColombiansandbox15 2.5Bankdisintermediationrisk15 2.5.1Domesticcurrencysubstitution16 2.5.2Reservecurrencysubstitution16 2.5.3Recentdevelopments:cryptoassetsaslegaltenderandcryptoassetpaymentcards17 2.6Capitalflowsrisk17 2.6.1Unknownresidency17 2.6.2Effectsonothermacrovariables18 2.6.3Recentdevelopments:cryptoassetsforremittances18 3.Transmissionmechanisms.18 3.1Cryptoassetmarkets19 3.2Non-financialusers20 3.3Traditionalfinancialmarkets21 3.4Indirectchannels22 4.RiskcatalystsinEMEs22 4.1Adoptionofcryptoassets22 4.2Economic,financialandinstitutionallandscapes23 4.3Technologicalinfrastructureandknowledge24 4.4Regulatorystance24 BoxA:CryptoregulationintheAmericas25 5.PrinciplesforregulatingandsupervisingcryptoassetmarketsinEMEs25 5.1Definingclearmandatesforregulationandsupervision29 5.2Activity-basedvsentity-basedregulation30 5.3Addressingdatagaps33 5.3.1Potentialpathsforward35 6.Conclusions35 References37 AnnexA:Glossary40 AnnexB:Taxonomy42 A.1Cryptoassetswithastabilisationmechanism42 A.2Fiat-referencedcryptoassets(“stablecoins”)42 A.3Tokenisedfunds44 A.4Cryptoassetswithoutastabilisationmechanism(unbackedcryptoassets).44BoxB.The2021–22cryptoassetmarketsboomandbust45 AnnexC:Taskforcemembers46 Foreword Thisreportdiscussestheevolvinglandscapeofdigitalfinanceandtherapidgrowthofcryptoassetsindepth,focusingonemergingmarketeconomies(EMEs).Ithighlightstherisksassociatedwithcryptoassetsintraditionalfinancialmarkets,includingmarket,liquidity,creditandoperationalrisks,bankdisintermediationandcapitalflowrisks.Thereportexaminesthevulnerabilitiesincryptoassetmarketsthatcontributetotheserisksandexploresthetransmissionchannelsthroughwhichtheseriskscanaffectfinancialstability.ItalsosuggestsprinciplesforregulatingandsupervisingcryptoassetmarketsinEMEs,focusingonclearmandatesforauthorities,differentiationbetweenactivity-basedandentity-basedregulation,andaddressingdatagaps.Thereportprovidesinsightsandguidelinesformanagingthefinancialstabilityrisksfromcryptoassets.ThespecialfocusonEMEsisparticularlyimportant,giventheirfinancialmarketcharacteristicssuchaslimitedaccesstoinvestmentandsavingsinstruments(insofarasmosthavebank-basedfinancialsystems),relativelylowfinancialliteracyandmorevolatiledomesticfinancialconditions.Overall,theseparticularitiesmakeEMEsmorevulnerabletosomeofthecrypto-relatedfinancialstabilityrisksthanareadvancedeconomies. ThereportistheoutcomeofworkconductedbyBISmembercentralbanksintheAmericaswithintheConsultativeGroupofDirectorsofFinancialStability(CGDFS).TherepresentativesofthecentralbanksofArgentina,Brazil,Canada,Chile,Colombia,Mexico,PeruandtheUnitedStatessetupataskforceledbytheBISAmericasOfficeasthesecretariat.Twogroups,coordinatedbytwoteamleadersfromColombiaandMexico,analysedunbackedcryptoassetsandso-calledstablecoins,respectively,fromafinancialstabilityandregulatoryperspective.TheBISAmericasOfficefosteredandcoordinateddiscussionsamongcentralbankmembersandengagedinconversationswithcryptoassetmarketsparticipantsandresearchersfromtheECB,BISandFSB.Thesediscussionsaimedatobtaininginsightsonthelatestdevelopmentsincryptomarketsfromindustryandpolicyperspectives.Ultimately,theseeffortshelpedtocatalysecentralbankworkthatcontributedtothekeyideasandresultssummarisedinthisreport. TheCGDFSwasoneofthefirstconsultativegroupsoftheBISRepresentativeOfficefortheAmericas.ItwasestablishedinApril2014withthreeobjectives,namelyto(i)implementregionalcentralbankconsultationsinfinancialstability;(ii)shareexperiencesinidentifyingandmitigatingsystemicrisks;and(iii)promotetheuseofkeyresearch.Inthisvein,thisreportconsolidatesamulti-countryefforttoinformthepublicofnoveldevelopmentsinthecryptoassetspace. AndrésMurcia AnnaKo