IMF calls for greater collaboration between DeFi and financial services in global financial stability report

In a report assessing the financial system’s resilience in the wake of a global pandemic and ongoing war between Russia and Ukraine, the International Monetary Fund (IMF) highlighted the opportunities and challenges facing defI and crypto. 

While discussions around cryptocurrencies of late have tended to fall into extremes of either positive or negatives sentiments, with governments and institutions eager to either adopt or prohibit the sale and development of digital assets, the IMF’s report attempts to strike a balance, highlighting the potential efficiency of decentralised finance while also warning against its misuse. To help you make sense of the report, we’ve gathered together and summarised the key highlights below.

Efficient but risky

In a positive result for alternatives to traditional finance, the IMF highlighted the ability of decentralised finance to offer a mix of risks and benefits, with growing adoption by institutional investors strengthening the links to traditional institutions. 

In its third chapter on the rapid growth of fintech, the report explained that defi has the potential to “offer financial services with even greater efficiency, becoming a gravitational force that attracts a large number of crypto investors”, but cautioned that this collaborative opportunity may also come at the cost of greater risks and uncertainties.

This cost comes as a result of the ability of defi-related products to bypass the traditional checks and regulatory frameworks put in place in centralised banks and other such lending platforms. However, the report goes on to explain that defi’s lower lending costs and higher yields come at the cost of potential exposure to higher risks such as lack of central bank and anti-money laundering (AML) support alongside legal and jurisdictional uncertainty. 

In his foreword to the report, Tobias Adrian, Financial Counsellor at the IMF called for an increase in “multilateral cooperation” as a key factor to help overcome these challenges of bridging the gap between traditional finance and defi and curbing the use of crypto assets in emerging markets to bypass capital restrictions and sanctions.

Reworking regulation

A topic never far from discussion around defi, the IMF’s report highlighted the issues a decentralised alternative presented for traditional regulators.

With governments across the globe attempting to adopt and issue their own stablecoins and other defi-related products, the IMF explains that this increasingly interconnected relationship demands an “enhanced and globally consistent regulatory framework” as banks and governments look to increase their exposure and funding from stablecoins.

According to the report, should a global effort be made to pursue a more interconnected system, it can only help improve the relationship between defi and the financial sector, which have traditionally been in competition with one another. 

One solution the report proposes is for regulators to target elements of the crypto ecosystem that have helped enable the development of defi. These include centralised crypto exchanges and hosted wallet service providers. As nations race to either ban or embrace crypto, such institutions are often on the backfoot when it comes to attempting to comply with the many intricate guidelines in each jurisdiction they operate in. Therefore, initiatives such as this could be of great value to these centralised services.

The IMF believes that a robust and comprehensive national regulatory framework that sets out common global standards much like the European GDPR approach to data protection could help these institutions streamline their compliance. Similarly, this could also lead to a creation of a new role for these institutions as liaisons/advisors between regulators and the growing defi space.

Using cryptocurrency to evade sanctions is impractical

With lawmakers warning that cryptocurrencies could be used to bypass sanctions and many nations now aware of the perils of depending on currencies weaponized by Western governments, it is a positive step to see the IMF dispel this myth in its report. 

Given the sheer amount of AML compliance within the crypto space, the use of cryptocurrency to evade sanctions is impractical, with the report explaining that while decentralised tokens and privacy coins may allow for some avoidance, it would be very minimal due to limited liquidity. 

If anything, the discussions around sanctions highlight the potential for cryptocurrencies like Bitcoin to serve as a more attractive reserve currency over traditional fiat currencies for countries due to the difficulty involved in attempting to freeze crypto assets.

Coordinate and overcome

While the sentiment on crypto throughout the report remained fairly consistent in its balance between positive and negative commentary, a clear theme of a greater need for consistency and collaboration can be seen. In particular, the need for a coordinated regulatory approach to crypto and greater collaboration between traditional finance and defi. Greater collaboration and precision in regulatory actions from lawmakers can only help prevent further fragmentation of the global payments infrastructure that the report warns against.