On February 23, 2023, the International Monetary Fund (IMF) published their recommendations for crypto assets in a paper titled Elements of Effective Policies for Crypto Assets. The recommendations consist of 9 elements that address questions imposed by IMF members on how to address the rise of crypto assets and their inherent risks. While these elements can be used to assist IMF member countries in developing policies for crypto assets, they are not meant to “fix” crypto laws and regulations; they merely act as a guide.
In this article, I will briefly review the 9 elements, clarify them, and provide recommendations or additional information to the reader. Before I begin my review, it is important to understand the purpose of the IMF.
The Purpose of the International Monetary Fund
The International Monetary Fund (IMF) was conceived in July 1944 at the United Nations Bretton Woods Conference. The 1930s Great Depression drove competitive currency devaluations and the 44 countries in attendance wanted to avoid repeating the same economic downturn.
Presently, the IMF has 190 member countries with the United States, Canada, United Kingdom, India, France, and others, being original members since December 1945.
The purpose of the IMF is to further international monetary cooperation, encourage the expansion of trade and economic growth and discourage policies that would harm prosperity. This is accomplished by open dialogue, providing financial support to countries impacted by crises (and precautionary financing to prevent crises) and strengthening the economic institutions of member countries. The funds come from member quotas which depend on the country’s size and world economic position.
Considering the volatile nature of crypto and the recent events where many crypto-handling companies face serious financial difficulties, it is important to adopt a more zoomed-out lens when reviewing the framework of the 9 elements, which has been difficult for many.
The Framework of the 9 Elements for Crypto
While reading the 43 pages of the IMF Policy Paper on the 9 elements and numerous articles published soon thereafter on the same subject, I decided to take a different approach to the subject matter at hand.
The reasoning for my approach was that most published articles focused on element No. 1 – “Safeguard monetary sovereignty and stability by strengthening money policy frameworks and do not grant crypto assets official currency or legal tender status.” I found it interesting that the first element, presented in the IMF paper, could have been the last one, given that it may be better to find a solution to a “problem” instead of dismissing it.
Cryptocurrency is known to be volatile; the price can fluctuate based on supply and demand, investor and user sentiments, government regulations (or lack thereof), and media hype. There could be issues related to who bears the risk if the value declines rapidly between the time when a payment is due, when it is made, and when it is received.
On the flip side, cryptocurrency also has benefits, such as the speed of transactions. Typical transactions at financial institutions (e.g. banks, and credit unions) can take up to five days to settle. Wire transfers typically take 24 hours and stock trades settle within three days. A crypto transaction can be completed in minutes.
Privacy may be one of the lures of cryptocurrency. Since a user does not have to register an account at a financial institution to transact with crypto, the user maintains a level of privacy. One of the common uses of cryptocurrency is to send money across borders with relatively low fees, as compared to the fees charged by financial institutions.
There are many disadvantages and advantages of cryptocurrency, but let’s explore the ones provided by the IMF.
9. Strengthen global cooperation to develop digital infrastructure and solutions for cross-border payments and finance.
Element’s summary: Take advantage of crypto technology (e.g. digital infrastructure, interoperable digital platforms, digital identification) to develop and address inefficiencies in the financial system (e.g. cross-border payments).
Observation: According to a BCC Research, the cross-border global market is projected to be $238 billion by 2027. Yet, cross-border payments have inefficiencies from a cost and time perspective, which results in expensive transaction fees and sometimes complicated payment processing methods. According to element No. 9, “Although not exclusively the domain of the underlying technology of crypto assets, tokenization, encryption, and programmability, new networks and platforms could improve the efficiency of transactions (Adrian et al. 2022).”
Let’s unpack this concept further.
Blockchain technology could potentially eliminate some of the existing inefficiencies by allowing payments to be made directly from one party to another reducing the cost of cross-border payments and making them more accessible to consumers and businesses internationally.
Cross-border payments are also vulnerable to fraud and other financial crimes involving multiple parties and complex transactions. Blockchain technology transactions can be used to track and verify payments in a secure manner, reducing cross-border fraud by increasing transparency.
8. Monitor crypto assets on the stability of the international monetary system.
Element’s summary: Addressing challenges and opportunities of crypto assets in the global environment. Banks, regulatory agencies, and congress should take action (e.g. monitor vulnerabilities and risks to the financial system) to ensure international cooperation integrating the global economy (e.g. appropriate regulation and international standards).
Observation: To put this into a broader context, cryptocurrencies are “loosely” regulated today at the federal and state levels. It is no surprise that many government entities would like additional cryptocurrency regulations to prevent the “‘Wild West.”
In the U.S., FinCEN works diligently to prevent and identify financial crimes and look at cryptocurrencies to detect financial crimes (e.g. money laundering). The Securities and Exchange Commission (SEC) regulates the stock market and other securitized investments. There have been hundreds of articles on the SEC and its authority over cryptocurrencies. The Commodities Futures Trading Commission (CFTC) regulates futures and commodities trading. There are several cryptocurrencies that trade under asset class umbrellas, placing them under CFTC oversight.
In the near future, the Federal Energy Regulatory Commission may have oversight to investigate the energy impact of cryptocurrency. Some cryptocurrencies have intense energy requirements, need special equipment and generate waste, according to Colombia Climate School State of the Planet.
State regulators, in particular New York, where cryptocurrencies must be registered to be available to local consumers have regulatory oversight. In today’s environment, cryptocurrencies are shifting towards a cleaner, greener future, and most energy comes from renewable sources, writes the World Economic Forum.
According to an article by the UN environment programme, blockchain is at the forefront of digital technology in accelerating action on issues of climate change and biodiversity loss. This technology is important to innovations in energy and climate in developing countries.
7. Establish international collaborative arrangements to enhance supervision and enforcement of crypto assets.
Element’s summary: National approach to regulation is limited by the borderless digital features of crypto assets (e.g. registering in one country and providing services in another country).
Observation: With the exception of a few countries, cryptocurrencies are mostly regulated on the federal or state level or both. International coordination and engagement are needed to create a regulatory framework for digital assets to help ensure market integrity and consumer protection.
Let’s break it down.
Crypto assets, cryptocurrencies, central bank digital currencies and non-fungible tokens each provide regulatory challenges and complexities. Regulations and restrictions may vary depending on payments, investments, derivatives, and taxes.
Today’s focus on digital assets has increased dramatically and will probably continue to increase over the next year. The same focus will also be on the regulators. Risk to market integrity demonstrates the need for a comprehensive global regulatory approach to ensure consumer protection.
A number of countries are researching, consulting, and passing legislation to bring digital assets under some type of international umbrella of financial services frameworks. However, the speed and approach of the regulators remain fragmented when dealing with the services and products covered under digital assets. Many crypto enthusiasts are hopeful 2023 will be the year when the “dust” finally settles and a regulatory framework is available for consumers, investors, and businesses.
6. Establish a joint monitoring of agencies and authorities to understand developments of crypto assets.
Element’s summary: In addition to regulations (e.g. AML/CFT, data collection), authorities in countries need a better grasp of the developments in the crypto industry (e.g. innovation, risks, and personnel).
Observation: The one agency that has been monitoring crypto assets is the Financial Action Task Force (FATF). FATF is the global money laundering and terrorist financial watchdog. More than 200 countries are committed to implementing standards set by the FATF to prevent organized crime, corruption, and terrorism. And according to the FATF, “Virtual assets have many potential benefits….But without proper regulation, they risk becoming a virtual sale haven for the financial transactions of criminals and terrorists.”
“The FATF has been closely monitoring the developments in the crypto sphere and in recent years has seen the first countries start to regulate the virtual asset sector….”
While there appears to be no lack of agencies overseeing cryptocurrencies in the U.S. – and no shortage of globally available information regarding cryptocurrencies – what continues to be absent are the conclusive and clear regulatory requirements for the industry.
5. Develop and enforce oversight of crypto asset providers.
Element’s summary: Regulation over banning crypto asset providers. Rules (AML/CFT, disclosures, transparency, regulations) similar to financial providers should be applied to entities that provide crypto assets.
Observation: There is no doubt that AML/CFT, as well as law enforcement, are needed to scale back the illicit use of crypto assets. Laws, rules, and policies can diminish criminal activities (e.g. turning unlawfully obtained cryptocurrency into cash).
In December 2022, U.S. Senators Elizabeth Warren (D-Mass) and Roger Marshall (R-Kan) introduced the Digital Asset Anti-Money Laundering Act of 2022 that would mitigate the risk of cryptocurrency and other digital assets posed to the national security of the United States. It was an effort to close the loopholes in AML/CFT and bring digital assets into compliance with the rules followed by the financial system.
Earlier, in October 2021, the FATF published updated guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers.
The guidance is a wealth of information for the private sector engaged or seeking to engage in virtual assets. It provides guidelines to countries, authorities, and the industry for the design and implementation of a risk-based AML/CFT regulatory framework (e.g. customer due diligence, record-keeping, SARs, and other measures).
4. Establish legal certainty of crypto assets and address legal risks.
Element’s summary: Clarifying the legal treatment of crypto assets (e.g. laws, rules) and mitigation of risks (e.g. tax laws). Legislative reforms.
Observation: To add more context, according to US GAAP, there is currently no authoritative literature that specifically addresses the accounting of crypto assets to include digital currencies. IRS Notice 2014-21 treats virtual currency as property for federal tax purposes.
On January 27, 2023, a Press Release by the White House addressed mitigating risk in cryptocurrencies, in part, by expanding powers to regulators to strengthen transparency and disclosure requirements for crypto-handling companies. It is the observation of the writer that law enforcement would benefit from additional funding for training, investigating violators and flexibility to work joint investigations with their international partners.
3. Analyze and disclose fiscal risks and adopt unambiguous tax treatment of crypto assets.
Element’s summary: The growth of crypto assets in a “weakly” regulated environment could result in financial risk. Regulation is required to address the tax treatment of crypto assets.
Observation: The IRS has released limited guidance on the tax consequences of crypto assets transactions with many issues unaddressed. The Infrastructure Investment and Jobs Act states an information return form (Form 1099-B, Proceeds from Broker and Barter Exchange Transactions) must be filled with the IRS by a party facilitating the transfer of cryptocurrency on behalf of another person as a broker (Sec. 6045(c)(1)(d)).
2. Guard against excessive capital flow volatility and maintain the effectiveness of capital flow measures.
Element’s summary: Ensure capital flow measures (e.g. designed to limit flow and to reduce systemic financial risks stemming from such flows), laws, and regulations (e.g. transaction taxes) to include crypto assets domestically and internationally.
Observation: When establishing “rules of engagement” for crypto to contain known risks, it is also important to look at crypto objectively, relying on data. For example, in December 2022, Shaktikanta Das, governor of the Reserve Bank of India (RBI) warned that cryptocurrency could cause the next financial crisis if the assets are allowed to grow due to not having any underlying value.
RBI Das stated three main concerns with cryptocurrency:
- “Private cryptos owe their origin to ‘breaking the system,’ and they do not believe in the regulated financial world.”
- “Cryptocurrency has no underlying basis, and there is no clarity on what public good or purpose they serve.”
- “It’s a 100 per cent [sic] speculative activity, making it a risky asset.”
Soon after RBI Das’ statement, crypto industry experts argued the assumptions were largely misplaced, as cryptocurrencies constitute only a tiny sliver of the global financial markets to cause any real upheaval.
According to a survey conducted by Bank of America in June 2022, crypto assets comprise about 1% of the total global financial assets. Other experts have pointed out that the crisis of Terra Luna or the FTX had no impact on the global financial market.
This brings me to the Number 1 element recommended by the IMF.
1. Safeguard monetary sovereignty and stability by strengthening money policy frameworks and do not grant crypto assets official currency or legal tender status.
- Maintaining monetary credibility is important.
- Transparent monetary policy framework to assist the public to understand monetary policy actions.
- Where fiscal deficits and debt levels are high, currency substitution (digital assets) would increase already high financing levels.
- “Currency” is recognized as banknotes and coins issued by the Treasury or the Central Bank. Therefore, unbacked crypto assets and stablecoins should not be recognized as “currency.”
- Significant financial and reputation risk may happen if a country decides to use cryptocurrency with the current international financial system (e.g. banks, IMF, central banks).
- Converting crypto assets to fiat currency should be avoided to help prevent exposure to liabilities.
Observation: Since the creation of Bitcoin in 2009, cryptocurrencies have exploded in popularity. And while critics blame the lack of regulation for the volatility in the industry, some governments have capitalized on the technology that powers cryptocurrencies to invest in their own digital currencies.
As of February 2022, the IMF indicated that approximately 100 countries, including the U.S., are considering introducing their own central bank digital currencies (CBDC). The Atlantic Council Central Bank Digital Currency Tracker indicates 114 countries are exploring a CBDC in 2023.
The question remains, however, whether crypto assets should be given legal tender status.
31 U.S.C. §5103 defines legal tender as “United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues. Foreign gold or silver coins are not legal tender for debts.”
It would seem §5103 would need to be modified to include crypto assets. But according to the Federal Reserve FAQs, “There is no federal statute mandating that a private business, a person, or an organization must accept currency or coins as payment for goods or services.” Furthermore, the Treasury Department Bureau of Engraving and Printing FAQs makes the same point as the Federal Reserve regarding the lack of a federal statute mandate to only accept the current legal tender.
The following aspects remain as challenges with cryptocurrencies:
- Ransomware attacks
- Drug cartels and money laundering incorporating virtual currency into their activities
Terrorism and sanctions evasion
- Some countries are using cryptocurrency to evade U.S. sanctions
- Terrorist groups trafficking in cryptocurrency
- Mining is highly energy-intensive
Volatility and lack of regulation
- Tax evasion
- Billions of dollars in transactions in a relatively unregulated sector
There are also several challenges that global regulators are facing when developing regulations for crypto assets:
- How to reduce financial risks and promote innovation at the same time?
- How to address the fact that cryptocurrencies do not fit into any existing regulatory framework? The SEC and the Federal Reserve have asked for stronger regulations from Congress.
In a world of uncertainty, following and using available regulatory intelligence tools is a good start for the crypto industry. If you have questions about managing regulatory change for your crypto-handling organization, please don’t hesitate to contact us here or visit our dedicated Digital Asset and Cryptocurrency Regulations page.
Disclaimer: The information provided is not meant as advice or legal guidance to invest, buy or sell digital assets. Regology does not take a position for or against the IMF or any other regulatory agency.