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.