Crypto boom poses risk to financial stability, IMF says

Regulators need to enact global standards to keep the risks associated with cryptocurrencies in check, the International Monetary Fund said on Friday.

In its latest Global Financial Stability report, the IMF called for “robust and globally consistent” standards to govern the crypto market, which has exploded in value in recent years, more than doubling this year alone for a market capitalisation of more than $2 trillion.

The crypto ecosystem is flourishing with new digital currencies, exchanges, wallets and miners but many of these entities lack “strong operational, governance and risk practices,” the IMF said.

To mitigate these risks, national regulators should enact global standards to govern the cryptocurrencies, the fund recommended.

Cryptocurrencies are vulnerable to cyber attacks and wild swings in value that can create financial instability. Users need to disclose only limited amounts of information and high levels of anonymity enable money laundering and terror financing, the fund found.

So far, such incidents have not had a significant impact on the broader stability of financial markets, but “as crypto assets become more mainstream, their importance in terms of potential implications for the wider economy is set to increase,” the IMF said.

It also added that crypto exchanges trading coins meeting the definition of securities (tradable financial assets) should be subject to existing international standards for securities intermediaries.

“All jurisdictions should implement such standards … [focus] on areas of acute risk, such as wallets, exchanges and financial institutions’ exposures. Authorities should ensure that the regulatory framework is flexible enough to be adjusted in the future, in line with forthcoming international standards,” the report said.

Cryptocurrency exchanges experienced a tenfold increase in phishing attacks in the first half of the year compared to the prior year period, cyber threat intelligence company PhishLabs said in its latest report, although it did not disclose the number of attacks.

Hackers pulled off the biggest cryptocurrency heist yet on August 10, stealing $613 million in digital coins from token-swapping platform Poly Network, only to return $260m worth of tokens less than 24 hours later.

“With inadequate disclosure … the crypto ecosystem is exposed to consumer fraud and market integrity risks. Most crypto assets are highly volatile, speculative assets,” the report said.

“Investors are also likely to face losses from tokens ceasing to exist — something that is less common in regulated securities markets. For example, more than 16,000 tokens have been listed on various exchanges over time, but around 9,000 exist today.”

Central banks around the world have been reluctant to endorse cryptocurrencies because of their speculative nature and regulatory oversight.

Last month, China, the world’s second-largest economy, vowed to root out “illegal” activity in the trading of Bitcoin — the world’s largest cryptocurrency - and other virtual currencies as it renewed tough talk on digital assets.

The Central Bank of the UAE also does not recognise cryptocurrencies as legal tender.

Monitoring crypto asset service providers is complicated by limited, fragmented and, in some cases, unreliable data.

Public data sharing by crypto asset providers is currently mostly voluntary and lacks standardisation.

The IMF suggested an international agreement be drawn up on common minimum principles for data usage in cryptocurrencies.

“There is also scope for international co-ordination on compilation and sharing of data sources from private companies for regulatory and public policy purposes,” the IMF said.

Greater data standardisation can lead to better oversight of new developments, more accurate understanding of risks and can support proportionate regulation of crypto asset markets, it added.

The banking sector can also come under pressure if the crypto ecosystem becomes an alternative to domestic bank deposits or even loans, the IMF cautioned.

Stronger competition for bank deposits through so-called stablecoins that are less subject to valuation shocks may push local banks towards less stable and more expensive funding sources to maintain similar levels of loan growth.

“Beyond the direct loss in net interest income, a loss of customer relationships and data on transactions would also undermine credit risk assessment for clients and their ability to offer targeted products to clients,” the report said.