While private digital currencies have enriched some individuals and institutions, they are an unstable financial asset that can carry “social risks and costs,” the agency warned.
According to UNCTAD, the United Nations Conference on Trade and Development, for some, their benefits of cryptocurrencies are overshadowed by the threats they pose to financial stability, domestic resource mobilization and the security of monetary systems.
Emergence of cryptocurrencies
Cryptocurrencies are an alternative form of payment. Transactions are done digitally through an encrypted technology known as blockchain.
The use of cryptocurrencies has increased globally at an unprecedented rate during the COVID-19 pandemic, reinforcing a trend that was already underway. Currently there are about 19,000.
In 2021, of the top 20 countries with the largest share of the population owning cryptocurrencies, 15 were developing countries.
Ukraine leads the list with 12.7%, followed by Russia and Venezuela with 11.9% and 10.3% respectively.
Not all that glitters is gold
The first note, titled “All that glitters is not gold. Not regulating cryptocurrencies is very expensive” – explores the reasons for the rapid adoption of cryptocurrencies in developing countries, including the facilitation of remittances and the inflation protection of fiat currencies.
But “recent shocks to digital currencies in the markets suggest that holding cryptocurrencies is risky. If a central bank steps in to protect their financial stability, the problem becomes public,” said UNCTAD.
Furthermore, if cryptocurrencies continue to evolve as a means of payment, or even to unofficially replace national currencies, it is the “monetary sovereignty” of countries that could be at risk.
With regard to developing countries that do not have reserve currencies, UNCTAD also highlighted the specific risk of “stablecoins”, or stable cryptocurrencies in French.
A stablecoin is a cryptocurrency whose price is tied to another cryptocurrency, fiat currency, or exchange-traded product (such as precious metals or industrial metals). As their name suggests, stablecoins are designed to maintain a stable value.
“For some of these reasons, the International Monetary Fund (IMF) has expressed the view that cryptocurrencies pose risks as legal tender,” the agency said.
UNCTAD’s second note focuses on the impact of cryptocurrencies on the stability and security of monetary systems, and on the stability of financial architecture in general.
“A national digital payment system for public services should address at least some of the reasons for the use of cryptocurrencies and limit the expansion of cryptocurrencies in developing countries,” said UNCTAD.
For example, monetary authorities could launch a digital currency through a central bank or a fast payment system for small purchases, although the measures depend on national capacities and needs.
However, UNCTAD urged governments to “maintain the issuance and distribution of cash” given the risk of widening the digital divide in developed countries.
Fear of tax evasion
The latest policy brief explores how cryptocurrencies have become a new conduit for undermining domestic resource mobilization in developing countries, and warns of the dangers of “too little, too late.”
While cryptocurrencies can facilitate money transfers, UNCTAD has warned that they can also facilitate fraud and encourage tax evasion through illicit money flows – much like a tax haven, where it is difficult to identify who owns what.
“Cryptocurrencies can thus also hinder the effectiveness of capital controls, an important tool for developing countries to maintain their policy space and macroeconomic stability,” the agency added.
UNCTAD presented several actions to stop the expansion of cryptocurrencies in developing countries.
The agency urged authorities to regulate cryptocurrency exchanges, digital wallets and decentralized finance.
Regulated financial institutions should be prohibited from holding cryptocurrencies, including stablecoins, or offering related products to their customers.
Advertising related to cryptocurrencies should also be regulated, as it would for other high-risk financial assets, according to UNCTAD, which advises governments to establish a public payment system “secure, reliable, affordable and adapted to the digital age”.
UNCTAD also advocates for global tax coordination regarding the tax treatment of cryptocurrencies, regulation and information sharing.
In addition, capital controls need to be redesigned to account for what the agency describes as “the decentralized, borderless nature of cryptocurrencies” and its users’ reliance on pseudonyms.