New technologies are changing the economic and financial landscape, and the G20 leaders must not miss the opportunity to actively discuss implementing a universal set of principles for related assets
Blockchain technology brings substantial benefits to the economic system and its application in the financial system – referred to as decentralised finance, or DeFi – are wide. Fungible and non-fungible tokens are traded globally on blockchains, and cryptocurrencies are among the most popular fungible ones. The opportunities created by DeFi are strictly related to the blockchain, where encrypted, anonymous, peer-to-peer trades are registered in public ledgers that use the proof of work or the proof of stake to solve the algorithm and validate the transactions. The main benefits of cryptos are the absence of limits to market access and the reduction of trading costs. However, blockchain trades are anonymous, unregulated and thus very risky.
bringing in new controls
Because G20 public authorities know that cryptos can be used for money laundering, they are introducing controls, although with limited results. Other than the traditional financial risks, such as risks related to the legal framework or lack of liquidity, excess volatility for investors – especially low-skilled ones – can be difficult for public authorities to deal with. In the first half of 2022, cryptos lost over half of their market value because rising uncertainty fuelled a ‘flight to quality’ by investors. The market shares of non-Bitcoin cryptos have steadily grown over the past year, thanks to the improved efficiency of blockchain that uses the proof of stake.
Innovation cannot be avoided, and countries approach this field in various ways. Those with less developed financial and banking systems can enjoy greater benefits from blockchain trades, but may encounter financial instability, since cryptos and other tokens are not insured or controlled by any public authority. G20 members have stable and developed financial systems, and face the dilemma between limiting innovation to guarantee stability and leaving investors free. The fear of losing DeFi market share has pushed most countries to introduce only a soft regulation of cryptos, treating them as currencies or as financial assets. However, the implementation of the rules is weak because of the evanescence in the digital world and the limitations of judicial systems. In fact, the main challenge that countries need to overcome is the geographical limits of domestic jurisdictions. Most countries are not even able to raise taxes from crypto trading.
New legal tender
Cryptos are not legal money, nor are they a store of value. Nonetheless, El Salvador decided to use Bitcoin, the most popular crypto, as a legal tender in its economy in June 2021; since then, the country’s economic situation has not improved and there are no substantial benefits. Central banks know that innovation moves faster than policy, and they have studied the creation of so-called central bank digital currencies. The creation of a digital euro or yuan can have positive effects on customers, but negative ones for banking institutions that risk complete disintermediation. Since the devil is in the details, the rules set for central bank digital currencies will determine the shape of the banking system.
G20 leaders at the Bali Summit in 2022 should actively discuss implementing a global set of soft principles for blockchain-related assets, fungible and non-fungible tokens, and smart contracts. To be successful, those rules should be applied globally to limit money laundering and reduce the excess volatility.