Crypto has ‘amplified financial risks’ in emerging markets, central banks warn

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Cryptocurrency assets have amplified rather than reduced financial risks in less developed economies, and regulators will need to treat them in the same way they oversee other assets, some of the world’s most powerful central banks have warned.

Novel solutions to payments challenges should not be classified as ‘dangerous’ simply because they are different, the Bank for International Settlements said on Tuesday. However the global central banking body added that the appeal of crypto was “illusionary”, in a paper published on approaches to regulation.

The Consultative Group of Directors of Financial Stability, which includes representatives from central banks of the US, Argentina, Brazil, Canada, Chile and Mexico, said crypto had been promoted as a low-cost payment solution and substitute for national currencies in countries with high inflation or high exchange rate volatility.

“However, crypto assets have so far not reduced but rather amplified the financial risks in less developed economies. Therefore, they should be assessed from a risk and regulatory perspective like all other assets,” it said in a 50-page report.

Watchdogs including the IMF and the Bank for International Settlements have been charting the evolving financial stability risks from the cryptocurrency market as it ballooned from a nascent industry to one whose value peaked at $2.9tn in November 2021.

Some were comforted by the limited blowback for the wider financial system as crypto’s value plummeted by 75 per cent within just over a year of its all-time high, but regulators including the European Central Bank have continued to warn of future risks, while global securities watchdog Iosco is pushing national authorities to be faster and bolder in their approach.

All but two of the top 20 countries for crypto adoption are emerging markets, with countries like Venezuela, El Salvador and Nigeria becoming test beds for whether cryptocurrencies could offer a balm to countries ravaged by inflation and depreciating official currencies.

But the central banks group said that crypto assets increased financial stability risks in emerging market economies, as a weaker rule of law could make it harder to enforce contracts, while “inconsistent enforcement can create confusion and raise market risk”.

The committee also cited the “combination of the lack of financial literacy and technological knowledge” in emerging markets as creating a “potent catalyst for risks to financial stability, especially concerning crypto assets.”

Beyond emerging markets, the BIS group said the case for a more risk-based approach to regulating crypto would become “even more pressing if crypto assets are more widely adopted by retail investors and if links with the traditional financial system increase”.

The UK’s crypto ownership more than doubled last year, the Financial Conduct Authority reported in June, with one in 10 owning some form of crypto by 2022. Around 17 per cent of Americans have invested in or traded in cryptocurrency, research from the Pew Research Centre shows, roughly unchanged from 2022 and 2021’s figures.