"IMF Global Financial Stability Report": Cryptocurrencies and DeFi play complex roles

The war in Ukraine in the wake of the coronavirus pandemic has tightened global financial conditions, according to the International Monetary Fund's (IMF) global financial stability report released on Tuesday. Rapid changes in fintech and the use and misuse of cryptocurrencies have exacerbated a series of challenges facing the global economy.

The report says the pandemic and war have led to an accelerated "cryptocurrencyization" in emerging markets due to increased speculative interest during the pandemic and then attempts to evade sanctions. The report found that using cryptocurrencies to evade sanctions is impractical given the industry’s compliance profile. Using mixers, decentralized exchanges, and privacy coins may allow some circumvention, but will be limited by limited liquidity.

A related risk is that sanctioned countries use excess energy (possibly accumulated as a result of sanctions) to mine proof-of-work cryptocurrencies, although the flow of funds from this activity will also be relatively restricted. Countries fearful of future sanctions may find cryptocurrencies more attractive as reserve currencies — while major fiat currencies are less so — thanks to the greater difficulty of taking cryptocurrencies out of circulation.

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

The report also said that regulation has not kept pace with the rapid development of fintech in many respects. Decentralized finance (DeFi) is increasingly connected to traditional finance due to its adoption by traditional financial institutions. DeFi lacks governance, which poses risks to financial stability and creates an environment of legal uncertainty. It is vulnerable to market, liquidity and cyber risks, but it may benefit from greater efficiency and financial inclusion.

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