Crypto adoption poses risks to emerging markets

The potential for cryptocurrency to lower transaction costs and increase financial inclusion in developing countries with poor banking infrastructure is promising, but the possibility of displacing local currency with a highly-volatile alternative also brings new risks, says Moody’s Investors Service.

In a new report, the rating agency said that cryptocurrency adoption rates have grown over the past couple of years, particularly in countries with lower sovereign ratings, where the costs of sending and receiving remittances is relatively high, and banking spreads are wide.

“Fast adoption of cryptocurrencies may lead to excessive financial fragmentation in payment systems and weaken financial stability,” the report said. “This has the potential to create a new type of banking system-sovereign nexus with possible negative implications for sovereign credit quality if left unchecked.”

Along with the well-established operational risks – such as the risks of fraud and cybersecurity, associated with crypto usage – developing countries could also see monetary policy undermined, Moody’s warned.

“Particularly for smaller economies, cryptocurrency adoption at a larger scale could limit monetary policy effectiveness and the ability of a central bank to control the domestic money supply,” the report said. This could reduce a developing country’s ability to use monetary policy to combat an economic crisis.

Moody’s said that the risks of increased crypto usage are highest for countries with weaker macroeconomic frameworks, including high, volatile inflation — which are also the kinds of countries where crypto adoption has increased due to their underdeveloped banking systems.

Indeed, the report noted that the countries with rising rates of crypto adoption “… also tend to have higher inflation volatility, with lower levels of policy effectiveness, and high levels of perceived corruption,” adding that they also tend to have stricter capital controls.

At this point, even in countries with high crypto adoption rates, overall risks remain low, Moody’s said, as crypto still remains small relative to traditional financial assets.

“The ability to harness the benefits of digital assets while containing risks will rest on policymakers’ ability to effectively regulate digital currencies,” the report concluded. “We expect the greatest risks for sovereigns with weaker macroeconomic frameworks, particularly where cryptocurrencies can be used to evade capital controls, weakening policy effectiveness.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.