EM Locals Turn to Stablecoins, Bitcoin, During Economic Stress: BIS Paper
Posted by Colin Lambert. Last updated: February 28, 2022
The popularity of cryptoassets in emerging market economies (EMEs) has increased in recent years, especially during periods of local currency depreciation, according to a paper published in the latest Bank for International Settlements’ Quarterly Review.
The paper observes that during local currency crises, holders of domestic fiat currencies have incentives to shift into claims denominated in more stable currencies. Cryptoassets pegged to reserve currencies, such as dollar-linked stablecoins, can be a convenient tool to do so, it explains, especially as they may help avoid capital controls and know-your- customer/anti-money laundering (KYC/AML) requirements.
“In the extreme case of sharp declines in the purchasing power of local fiat currencies and stringent capital controls, some may even seek refuge in highly risky cryptoassets such as Bitcoin,” the paper says. “As ‘cryptoisation’ is akin to currency substitution (eg “dollarisation”), it may impinge on monetary sovereignty.”
Although the authors acknowledge that detailed information on crypto trading locations is typically very limited, they use trading patterns involving EME currencies to provide novel empirical evidence on the phenomenon. Trading of dollar-linked stablecoins vis-à-vis some EME currencies has soared since 2020, the authors find, adding that although the US dollar remains the dominant fiat currency, the Turkish lira and the Brazilian real, for instance, accounted for much higher shares in stablecoin trading than in conventional FX trading, as captured by the BIS Triennial Survey. “Tellingly, trading of stablecoins vis-a-vis these EME currencies gained momentum in early 2020, when the corresponding economies were hard hit by the Covid-19 shock,” the paper states. “In particular, the share of the Turkish lira increased from 0.3% in January to 11% in April 2020. As the lira further depreciated in 2021, its share picked up from 11% in July to 26% in December 2021. This dwarfs the lira’s weight in global FX markets (0.5%).”
Stronger depreciation pressure on such currencies went hand in hand with larger volumes of P2P trading in Bitcoin
It was not only about the safety of stablecoins, however, for the research finds that Bitcoin trading volumes also spiked in some EMEs facing depreciation pressure. For EME currencies that have small liquidity pools and are thus not suitable for trading in limit order books on centralised crypto exchanges, the spike surfaced on peer-to-peer (P2P) platforms, the paper says. “In a sign that residents may have tried to avoid losses of purchasing power, stronger depreciation pressure on such currencies went hand in hand with larger volumes of P2P trading in Bitcoin,” the paper states. “By contrast, for EME countries whose currencies can be used in centralised exchanges (eg Turkey and Brazil), the P2P volume did not increase substantially, even though their exchange rates were highly volatile.”
Inevitably perhaps, given what appears to be persistent concerns about the impact of cryptoasset popularity on financial stability, the paper sounds a warning over this trend as well, noting, “The increasing usage of cryptoassets in EMEs, especially during periods of elevated FX volatility, could – over time – contribute to economic instability.”
The authors do stress that the degree of cryptoisation thus far remains limited, but also warn that its growth could ultimately divert away some of the funding of local banking systems. “As cryptoisation circumvents restrictions on exchange rates and capital controls, it can limit the effectiveness of domestic monetary policy transmission, in turn posing a threat to monetary sovereignty,” the paper states. “In addition, if some cryptoassets were widely adopted as a means of payment, problems with these assets – such as disruptions to stablecoins or risky cryptoasset price crashes – could spill over to payment systems and adversely affect real economic activity.
“Such risks are further compounded by ‘unknown unknowns’ – in particular due to the lack of transparency about ownership of cryptoassets,” it adds.