The advent of digital currencies in emerging markets could spark "cryptoization" of local economies, potentially undermining exchange and capital controls and upsetting financial stability, the International Monetary Fund said on Friday.
Bitcoin and its kin have in the last year soared in price and popularity, with emerging and developing market economies such as Vietnam, India and Pakistan seeing rapid growth in some measures of adoption, according to US blockchain researcher Chainalysis.
Cryptocurrencies offer, in theory, a cheaper and quicker way of sending money across borders. Backers say digital tokens such as stablecoins could also help protect savings from high inflation or fluctuations in local currencies.
In September, El Salvador became the first country in the world to adopt bitcoin as legal tender, with backers tipping the experiment to lower costs for billions of dollars of remittances sent to the Central American nation.
The IMF said that unsound macroeconomic policies and inefficient payment systems are among the drivers of cryptocurrency adoption in emerging economies, along with the lure of quick gains that has also excited investors across the world.
But the IMF said the exact level of adoption of crypto in emerging economies was hard to gauge accurately.
Factors such as low credibility of central banks and weak domestic banking systems that can fuel "dollarization" can also contribute to growing crypto use, the Fund added.
Dollarization is where a foreign currency - typically the U.S. currency - is used in addition to, or instead of, a domestic currency. High inflation or the instability of a domestic currency are among the drivers of the process.
Wide adoption of stablecoins - digital tokens designed to hold a steady value and seen as useful for savings and commerce - could also pose significant challenges by reinforcing existing dollarization forces, the IMF said.
"Dollarization can impede central banks' effective implementation of monetary policy and lead to financial stability risks through currency mismatches on the balance sheets of banks, firms, and households," it said.
"Cryptoization" could also become a threat to fiscal policy, with digital assets possibly facilitating tax evasion, the IMF added.
The fund urged developing nations to strengthen macroeconomic policies and consider the possible benefits from issuing central bank digital currencies as a response to the rise of crypto.
Interested in cryptocurrency? We discuss all things crypto with WazirX CEO Nischal Shetty and WeekendInvesting founder Alok Jain on Orbital, the Gadgets 360 podcast. Orbital is available on Apple Podcasts, Google Podcasts, Spotify, Amazon Music and wherever you get your podcasts.