How to control the influx of cryptocurrencies in developing countries? Not all that glitters is gold

Although cryptocurrencies have benefited individuals and facilitate remittances, they are an unstable financial asset that can also carry risks and social costs, the United Nations Conference on Trade and Development warned on Wednesday.

The Conference has published three reports that delve into these dangers, including the threats that digital currencies pose to financial stability, domestic resource mobilization, and the security of monetary systems.

Not all that glitters is gold

The first analysis examines the reasons for the rapid adoption of cryptocurrencies in developing countries, including the facilitation of remittances and the supposed protection against currency and inflation risks.

Recent market turmoil suggests that holding cryptocurrencies poses private risks, but if central banks step in to protect financial stability, the problem becomes public.

Regardless of the reason cryptocurrencies are used, cryptocurrency exchanges or markets play a crucial role in enabling their wider deployment.

Such markets function as clearinghouses, brokering conversions between cryptocurrencies and sovereign currencies.

There are now more than 450 crypto exchanges which, as of May 2021, reached a combined estimated value of $500 billion in daily trading, equivalent to the maximum of daily operations reached on the Nasdaq, the second largest stock exchange in the world.

The largest exchange, which has 28 million users, reached a record level of daily operations in November 2021, with 76,000 million dollars in transactions.

“The returns from trading and holding cryptocurrencies are, like those from other speculative operations, very individual,” highlights the report, adding that, in general, they are overshadowed by the risks and costs involved in the countries. Developing”.

And he concludes: “There are several reasons to be cautious.”

First of all, the use of cryptocurrencies can lead to risks of financial instability. If prices crash, monetary authorities may have to intervene to restore that financial stability.

Furthermore, in developing countries, the use of cryptocurrencies provides a new channel for illicit financial flows.

Second, the use of cryptocurrencies undermines the effectiveness of capital controls, an essential instrument in developing countries to curb the build-up of macroeconomic and financial vulnerabilities, as well as to increase policy space.

Lastly, if left unchecked, cryptocurrencies can become a widespread means of payment and even replace national currencies.

unofficially (a process called cryptography), which could endanger the monetary sovereignty of countries.

The use of so-called stable currencies poses the greatest risks in developing countries with unsatisfied demand for reserve currencies. For example, the May 2022 turbulence caused a flight to other higher-quality stablecoins that post audited holdings of their backers.

The International Monetary Fund has raised concerns about the risks of using cryptocurrencies as legal tender.

The report warns that if cryptocurrencies become a widespread means of payment and even substitute national currencies unofficially, this situation could endanger the monetary sovereignty of countries.

Public payment systems in the digital age

The second study addresses the implications of digital currencies for the stability and security of monetary systems and for financial stability.

It is argued that a national digital payment system that acts as a public good could respond to some of the reasons for the use of cryptocurrencies and limit their expansion in developing countries.

Depending on their possibilities and national needs, the monetary authorities could provide a digital currency at the central bank level or a fast retail payment system.

Given the risk of accentuating the digital divide in developing countries, the Commission urges the authorities to maintain the issuance and distribution of cash.

The cost of acting too little too late

The last report examines how cryptocurrencies have become a new instrument undermining domestic resource mobilization in developing countries.

Although the document reasons that digital currencies can facilitate remittances, they can also encourage tax evasion and avoidance through illicit flows, acting as if they were a tax haven where it is not easy to identify ownership.

In this way, cryptocurrencies can also reduce the effectiveness of capital controls, a key instrument for the preservation of political space and macroeconomic stability in developing countries.

recommendations

The Conference urges the authorities to take the following measures to curb the expansion of cryptocurrencies in developing countries:

• Establish comprehensive financial regulation of cryptocurrencies by regulating cryptocurrency exchanges, digital wallets, and decentralized finance, and prohibit financial institutions from holding cryptocurrencies (including stablecoins) or offering related products to the clients.
• Limit advertising related to cryptocurrencies, as with other high-risk financial assets.
• Offer a secure, reliable and economical public payment system adapted to the digital age.
• Agree and implement a global tax coordination in terms of tax treatment, regulation and exchange of information on cryptocurrencies.
• Reformulate capital controls to consider the decentralized, borderless, and pseudonymous properties of cryptocurrencies.