IMF proposes regulatory framework for fragmented crypto industry

The International Monetary Fund (IMF) published a report on Wednesday highlighting the regulatory architecture and responses required to deal with the risks of the ever-growing cryptocurrency market. 

Titled Regulating the Crypto Ecosystem: The Case for Unbacked Crypto Assets, the paper suggests that the growing systemic implications of crypto assets "may warrant immediate regulatory actions". Regulators are called upon to use their existing powers and focus on vulnerable areas of the industry, such as hosted wallets, decentralized exchanges and financial institutions’ exposure to cryptocurrencies.

Following the collapse of stablecoin Terra in May, which subsequently wiped $600bn worth of crypto from the industry and crypto markets downturn which has seen its $3tn market cap recorded in November 2021 slashed to $1tn at the time of writing, regulators have scrambled to bring the crypto market into the remit of regulators.

In response to the market events, the IMF report highlights the potential regulatory responses to key risks in the industry. It underscores that although sector-specific global standards are useful, cross-sectoral coordination is vital to achieving an effective regulatory framework for the crypto ecosystem. 

A central macro-recommendation addressed in the report pertains to the absence of legal certainty across jurisdictions. The report notes the regulatory fragmentation in the crypto space – with stablecoins in particular a hot topic among regulators due to their systemic importance to the crypto space and potential negative spill-over effects they could have on the traditional financial industry.

For instance, in the EU, the markets in crypto-assets (MiCA) framework agreed in July lays down a framework for the reserve backing, custody and liquidation requirements for stablecoin issuers to operate in the EU. Crucially, under MiCa issuers must be a legal entity within the EU, with no regime for third country issuers entertained in the framework. 

However, out of the big three stablecoins which account for more than 90 per cent of the stablecoin market – Tether, USDC and BUSD – are all headquartered outside of the EU, in the Bahamas, and US respectively. As a joint letter by the Blockchain for Europe and Digital Euro Association highlights, Euro-referencing-backed stablecoins account for 0.2 per cent of the market compared to the 75 per cent of the stablecoin market denominated in other fiat currencies – predominantly the dollar. 

Conversely, in the US, the Lummis-Gillibrand Digital Asset Bill aims to disentangle the regulatory conundrum faced by the Securities and Exchange Commission (SEC) which views crypto as a security and the Commodities Futures Trading Commission that have emphasised that crypto is a commodity. Other qualms addressed concern crypto-custody regulations and the potential for traditional banks to issue their own stablecoins. 

In the UK, the Financial Services and Markets Bill unveiled in July and currently being debated in the House of Commons has defined stablecoins as a "digital settlement" asset, with no indication that other cryptocurrencies will be brought into the remit of regulators. Conversely, the Law Commission of England has proposed a new law that would include non-stablecoins and NFTs into the UK's legal framework. 

The IMF report suggests that the appropriate regulatory response of regulators should include the "enhancement" of legal powers and the "establishment of a legal basis for domestic regulatory coordination and cross-border cooperation". 

Another key highlight of the report is the "determination of legal classifications of crypto assets". As noted above, the three major jurisdictions remain disjointed when it comes to their crypto and stablecoin regulations, with the taxonomy of cryptocurrencies differing. In response, the IMF has proposed the following taxonomy: 

Other focuses of the report revolve around effective monitoring, financial stability, consumer protection, market integrity and cross-border cooperation. Issuers, crypto asset exchanges, wallet providers and regulated institutions are all apparent in the report. 

Table 1 highlights the potential regulatory responses to key risks. It further underscores that although sector-specific global standards are useful, cross-sectoral coordination is important to achieve an effective regulatory framework for the crypto ecosystem. 

The report concludes: "Regulators need to continuously monitor the crypto asset landscape to understand the direction of industry developments."