The International Monetary Fund (IMF) has released a staff paper that examines the risks and use cases of virtual currencies such as bitcoin, recommending a balanced regulatory framework that will not stifle innovation.
The report was presented by IMF Managing Director Christine Lagarde at the World Economic Forum in Davos during the panel "Transformation of Finance".
Following an an overview of virtual currencies, the report goes on to look at the potential implications of the use digital currencies (a definition that includes mobile coupons and airline miles) as well as distributed ledgers and blockchains.
Notably, the paper concludes that distributed ledgers have the potential to change finance by reducing costs and allowing for deeper financial inclusion in the long run.
The publication follows remarks issued by chief of the IMF Christine Lagarde in which she told the banking industry any disruption from such technologies is likely to take time.
Advantages for money transfer
The paper cites the potential for the technology to cut costs in remittances, where transaction fees via 'traditional' platforms can be high - with the global average being 7.7%.
Recognising that the cost of sending funds via the bitcoin network is estimated to be about 1%, it points out that "blockchain-based intermediaries" already offer money transfer services via bitcoin in countries such as Kenya and the Philippines.
The introduction of distributed ledgers, it says, could also reduce the time it takes to settle securities transactions, which currently take up to three days.
The paper continues:
"Not only is this time-consuming, but trading parties also face settlement and counterparty risks. Major financial institutions have been investing substantially in this area. For example, Goldman Sachs applied for a patent on its blockchain-based settlement system (SETLCoin) in late 2015."
The development of smart contracts, the report continues, could further boost the efficiency of transactions and settlements in the securities industry.
However, it noted they could introduce risks to financial stability by "automatically propagating adverse events through the financial system".
Regulatory and policy challenges
The IMF further examines the regulatory and policy challenges presented by virtual currencies in a number of areas of risk, including consumer protection, money laundering and financing of terrorism, taxation, exchange and capital controls, and monetary policy.
Still, it cautions that global authorities are likely to face difficulties in arriving at clear and consistent definitions due to their international reach "decentralized nature [that] does not fit easily within traditional regulatory models".
In conclusion, while recognising the difficulties of the challenges set out above, the paper recommends the creation of regulatory frameworks for virtual currencies at both the domestic and international levels that guard against risks without "suffocating" innovation.
"Virtual currencies and their underlying technologies can provide faster and cheaper financial services, and can become a powerful tool for deepening financial inclusion in the developing world," said Lagarde.
"The challenge will be how to reap all these benefits and at the same time prevent illegal uses, such as money laundering, terror financing, fraud, and even circumvention of capital controls."
For more information, read the full report below: