The World Economic Forum’s Digital Currency Governance Consortium has published a comprehensive analysis of the macroeconomic impact of cryptocurrency and stablecoins.
The impetus for this research was a rising concern around the potential spillover effects of crypto and stablecoins on the financial system. Because of this, regulation and safeguards for crypto are at the top of many agendas. In the United States, the White House released a series of reports this year while the European Council recently approved the Markets in Crypto-Assets (MiCA) Regulation.
Our research aimed to project the economic outcomes of crypto and stablecoins, given the various high-level regulatory paths it could take. We sought to arm policymakers and business leaders with the necessary projections to inform decision-making in these dynamic spaces.
Data gaps in digital currencies
The Financial Stability Board (FSB) published a comprehensive report on the mounting potential for broad-reaching spillover effects and a list of data gaps for crypto and stablecoins. These data gaps illustrate why it’s more difficult to project outcomes as precisely as we can in the traditional financial system.
Proper macroeconomic models are also not widely available for crypto and stablecoins because monetary and financial statistics preclude them.
We’ve surveyed and mapped economists’ perspectives across a broad range of regulatory paths to capture all plausible scenarios and outcomes. Secondly, we identified criteria for positive macroeconomic outcomes with a general and global lens, then projected the effects of high-level regulation by criteria to identify which high-level regulatory path would yield the best economic outcome for society. Finally, we made some recommendations.
Economic roles of cryptocurrencies and stablecoins
While the general concept of crypto and stablecoins are broadly known, it is necessary to dissect their definitions in terms of their role in an economy.
Cryptocurrencies represent novel payment instruments and infrastructures that aim to form a new rail to existing payment systems. They add to the continuation of money and may complement or substitute existing money. Cryptocurrencies also form part of diversification in asset holdings and potentially in payments.
Stablecoin, on the other hand, is a DLT-based cryptocurrency designed to maintain a stable value relative to another asset. It originated from a demand for a stable monetary unit in distributed ledger applications and is used more frequently for transactions than crypto.
Fiat-backed stablecoins hold 1:1 reserves of fiat currency and the promise of convertibility.
The macroeconomic outcomes for crypto
The industry should consider the below economic outcomes when designing regulations for cryptocurrency:
1) Financial Stability
Central authorities are concerned with financial stability, as they cannot set adjustable monetary policies with crypto. Any abrupt decrease in value might result in a loss of investor confidence and have broad market effects. In some emerging markets, crypto adoption has accelerated due to unsound local policies or inefficient payment systems. Because of this, there is a risk of capital control measures being circumvented.
Crypto may be more attractive to those who may perceive themselves to be oppressed by the current financial system. In the U.S., Black Americans’ higher exposure to cryptocurrencies has left some more vulnerable to the recent economic downturn. One civil society CEO commented, “Consumer protection triggers mixed emotions for people of colour. The intent may be to protect people from exploitation, but those instincts are paternalistic. Instead, we should ask: how do people of colour benefit from decentralization?”
Crypto has an advantage over cash when moving large amounts of value across borders. If, however, these passages are managed using KYC/ AML measures, most transactions would be traceable. CipherTrace analysts found that less than 1% of transactions with crypto are nefarious. Yet, 98% of ransomware uses crypto. The government’s ability to investigate crypto-related crimes is limited in countries where crypto is unregulated.
Innovation in the crypto space is happening rapidly, creating a multiplier effect of new concepts like NFTs and the metaverse. If citizens gain crypto in the metaverse, it could create net wealth. If these proceeds were to be carried outside the metaverse and are substantial, this could have an aggregate demand effect that results in economic growth.
5) The importance of macro-critical environmental sustainability
The consensus mechanism for crypto is energy intensive. While crypto alone certainly cannot tackle climate change, some believe that the industry has the potential to provide incentives for sustainability and grid decarbonization, which the World Economic Forum’s Crypto Sustainability Coalition is exploring.
Regulatory paths for crypto
All macroeconomists interviewed for this analysis agreed that adopting crypto as a legal tender is not the optimal way to promote digital adoption or financial stability.
In the case of El Salvador, remittance costs are already close to the United Nations Sustainable Development Goal (SDG) target. Economists fear that when the country’s revenue and debt are managed in the US dollar and bitcoin, the national debt could skyrocket during dramatic swings in bitcoin price. Other countries in Latin America considering the adoption of crypto as legal tender should consider the impacts of volatility on individuals and the central bank balance sheet.
Thus, letting crypto play a regulated role in economies is the optimal way to promote the advantages of innovation while curtailing the potential downsides.
The macroeconomic outcomes for stablecoins
The industry should consider the below economic outcomes when designing regulations for stablecoins:
1) Financial stability
Fiat-backed stablecoins reserves comprise a portfolio of securities that have some duration. If all users of stablecoins were to redeem them for fiat simultaneously, the central issuer of that stablecoin would be unable to sell all the reserve portfolio holdings instantly.
Sudden asset liquidation could generate somewhat mysterious contagion effects. For example, TerraUSD, an algorithmic stablecoin, experienced a death spiral event earlier this year, which had puzzling spillover effects on the fiat-backed stablecoin, Tether.
Both currencies may extend their financial reach by relying on more effective distribution models. Fiat-backed stablecoins present potentially cheaper alternatives for cross-border transactions and would be desirable wherever remittances are high.
Stablecoins may offer more efficient means of conducting payments, reducing transaction costs, and enabling new business models. It can also coexist with future central bank digital currencies (CBDC) and create competition between the public and private sectors. As such, innovators argue that there is a broader opportunity to decentralize, democratize, and build a better internet.
Therefore, like crypto, stablecoin’s regulated role in economies will create the greatest macroeconomic net benefit to society.
With regulations actively being considered, it is important to prioritise taking action as soon as possible.
- Policymakers should create an international classification framework with nuanced regulations
- Crypto and stablecoins should be included in monetary and financial statistics
- Governments should coordinate with other governments to mitigate regulatory arbitrage and consider economic projections when designing regulations
- Businesses should proactively work in partnership with regulators when designing business models
Allowing cryptocurrencies and stablecoins to play a regulated role in economies will have a major macroeconomic net benefit.
The goal for the future should be to embrace the innovations that cryptocurrency and stablecoins bring while using regulation to curtail the risks to the economy.
Source: World Economic Forum