Why in news?

• The International Monetary Fund (IMF) issued a statement on the use of cryptocurrency in the Latin America and Caribbean market, and about the rising interest in blockchain-based central bank digital currencies (CBDCs).
• The IMF ended its statement noting that a ban on crypto “may not be effective in the long run” in the region.
• This has raised eyebrows due to the international organisation’s change in stance on crypto in the Latin American market.
  • Earlier, IMF had said that rapid growth and increasing adoption of crypto assets pose financial stability challenges as these are extremely volatile.
  • This was highlighted in the chapter titled The Crypto Ecosystem and Financial Stability Challenges published in Global Financial Stability Report 2021.

What’s in today’s article?

• What is cryptocurrency?
• What is central bank digital currencies (CBDCs)?
• What is the difference between cryptocurrency and CBDCs?
• News Summary

What is cryptocurrency?

• Cryptocurrencies are digital or virtual currencies in which encryption techniques are used to regulate the generation of their units and verify the transfer of funds.
• These currencies operate independently of a central bank.

Growth of crypto ecosystem presents new opportunities

• Technological innovation is ushering in a new era that makes payments and other financial services cheaper, faster, more accessible.
  • It allows these services to flow across borders swiftly.
• Bank deposits can be transformed to stable coins that allow instant access to a vast array of financial products and allow instant currency conversion.
• Decentralised finance could become a platform for more innovative, inclusive, and transparent financial services.

Challenges posed by crypto assets

• The rapid growth and increasing adoption of crypto assets also pose financial stability challenges as these are extremely volatile.
  • These are much more volatile than equities or commodities or even exchange rates.This volatility is introducing instability in the ecosystem.
• Challenges posed by the crypto ecosystem include
  • operational and financial integrity risks from crypto asset providers,
  • investor protection risks for crypto-assets,
  • inadequate reserves and disclosure for some stable coins.

What is central bank digital currency (CBDC)?

• CBDCs are digital currencies issued by central banks. Their value is linked to the issuing country’s official currency.
• In other words, CBDCs are the legal tender issued by a central bank in a digital form.
  • The digital rupee (e-Rupee) is the digital currency launched by Reserve Bank of India.
• It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency, only its form is different.
• CBDCs are similar to—but not the same as—stablecoins.
  • Stablecoins are a specific type of private, stabilized cryptocurrency pegged to another currency, commodity, or financial instrument with the goal of maintaining a relatively stable value over time.

What is the difference between cryptocurrency and CBDCs?

• Role of central bank
  • Cryptocurrencies and CBDCs are both blockchain-based digital currencies.
  • However, cryptocurrencies are generally run by private companies or individuals.
  • On the other hand, a CBDC is controlled and tracked by a country’s central bank and corresponds to that country’s fiat currency.
• Volatility
  • Bitcoin’s price may vary by hundreds or even thousands of dollars in a short period of time.
  • On the other hand, a CBDC would (ideally) be worth as much as its physical counterpart.
• Investment vehicles
  • Investors often buy large quantities of Bitcoin or other cryptocurrencies and hold them in the hope of making a profit.
  • This doesn’t make sense in the case of CBDCs as they are not meant to be investment vehicles.

News Summary: IMF’s view on cryptocurrency in Latin America

Why is Latin America’s crypto economy so significant?

• Countries like Argentina, Chile, and Columbia have experienced devaluation of their currency against the U.S. dollar.
• To preserve the value of their savings, some residents have explored converting their funds to U.S. dollars. However, there are legal restrictions controlling this.
• Others have chosen to convert their assets to stablecoins - cryptocurrencies designed to reflect the value of fiat currencies such as the U.S dollar.
• A number of central banks in the Latin American market are also considering CBDCs, meaning that more people could soon be exposed to blockchain-based infrastructure.

Why does El Salvador stand out among crypto economies?

• El Salvador is the first country in the world to adopt Bitcoin - the largest cryptocurrency by market capitalisation - as its legal tender.
• El Salvador uses a digital wallet known as Chivo to regulate users’ crypto transactions.

How did the IMF react to El Salvador’s Bitcoin adoption?

• The IMF said it was against El Salvador’s move, citing fiscal risks and consumer protection issues.
• This is why IMF’s latest blog post on crypto and CBDC use in Latin America and the Caribbean came as a surprise to many.
  • The post said that while a few countries have completely banned crypto assets given their risks, this approach may not be effective in the long run.
  • It called for regulation of cryptocurrency and recording crypto transactions for transparency.