Cryptocurrencies as Threat to Financial Stability

James Emejo writes that despite their potential to deepen financial inclusion among others, cryptocurrencies pose significant threats to financial stability in the country, calling for stricter regulatory and supervisory regimes

The disruptive tendencies of cryptocurrency assets to monetary policy implementation were again highlighted recently even as the Naira struggled to stabilise against major currencies particularly the United States Dollar in recent times.

The Naira had been under unprecedented pressure following the critical reforms currently being implemented in the Nigerian Foreign Exchange (FX) market, which had been compounded by supply-side constraints.

However, crypto assets, especially Binance have also been identified as agents of financial instability in recent times given that the cryptocurrency space remained largely unregulated, a condition that makes them appeal to money-laundering and other financial crimes – as well as contribute to money-induced inflation in the economy.

Binance is one of the largest cryptocurrency exchanges in the world and offers a platform for users to buy, sell, and trade a wide variety of cryptocurrencies as well as offers services including deposit taking, withdrawals, spot trading, futures trading, margin trading, staking, lending, among others. It also offers its own native cryptocurrency called Binance Coin (BNB), which can be used to pay for trading fees on the platform and access various features within the Binance ecosystem. Over the years, Binance has grown rapidly and expanded its services to include a range of financial products and services related to cryptocurrencies.

Unhealthy competition

However, Binance and other cryptocurrency exchanges pose immediate and potential risks to local or traditional currencies in several ways.

Cryptocurrencies traded on platforms like Binance can compete with traditional fiat currencies as a medium of exchange, especially in regions where there are concerns about inflation, government instability, or lack of trust in local currencies.

This is particularly true in the Nigerian experience where lack of confidence in the Naira had led to a near dollarisation of the economy, further fueling inflationary pressures and weakening the exchange rate.

If cryptocurrencies gain widespread acceptance and adoption, they could potentially diminish the importance of traditional currencies.

Furthermore, its global accessibility can bypass traditional financial systems and facilitate cross-border transactions, potentially reducing reliance on local currencies for international trade and remittances.

If anything, crypto assets have raised regulatory concerns and scrutiny from governments and central banks worldwide and some authorities view cryptocurrencies as a potential threat to financial stability, monetary policy control, and taxation. Regulatory actions or restrictions on cryptocurrency exchanges like Binance could affect their operations and limit their impact on traditional currencies.

Volatility and speculation

The volatile nature of cryptocurrencies, including those traded on platforms like binance, could further impact investor confidence in traditional currencies as high volatility may attract speculative behaviour, drawing investment away from traditional assets like fiat currencies, stocks, or bonds.

Although crypto assets pose challenges to traditional currencies, their impact varies depending on factors such as regulatory environment, adoption rates, technological developments, and public perception. Additionally, many governments including the CBN are exploring ways to incorporate blockchain technology and digital currencies, particularly the e-Naira into their existing financial systems, potentially mitigating some of the perceived threats posed by cryptocurrencies.

Regulatory interventions

Following concerns, the federal government recently reportedly restricted the operations of online platforms including Binance and other crypto firms to protect financial consumers from losing money and also safeguard the economy from speculative activities against the local currency amid the current challenges in the FX segment.

Despite their ability to enhance financial inclusion by removing the encumbrances in traditional financial system, they have also constituted real threats to the monetary authority. Given their disruptive tendencies, the CBN in February 2021 issued a circular restricting banks and other financial institutions from operating accounts for cryptocurrency service providers given the money laundering and terrorism financing (ML/TF) risks and vulnerabilities inherent in their operations as well as the absence of regulations and consumer protection measures.

However, last month, the central bank unveiled new guidelines to regulate the operations of bank accounts for Virtual Assets Service Providers (VASPs), otherwise known as cryptocurrency as current trends globally have stressed a need to regulate the activities of virtual assets service providers (VASPs), which include cryptocurrencies and crypto assets.

The framework provides minimum standards and requirements for banking business relationships and account opening for VASPs, and creates effective monitoring of the activities of banks and Other Financial Institutions (OFIs) in providing service for Securities and Exchange Commission (SEC) licensed VASPs/Digital Assets (DA) entities in the country.

Among other things, the document also seeks to ensure effective risk management in the banking industry with regard to the operations of licensed VASPs. The new guidelines followed the lifting of the ban that previously barred banks from operating accounts for crypto assets, although banks are still not allowed to hold or trade in crypto assets themselves.

CBN Director, Financial Policy and Regulation Department, Mr. Haruna Mustafa, in a circular addressed to banks and other financial institutions, stated however, that banks are “still prohibited from holding, trading and/or transacting in virtual currencies on their own account”.

The apex bank said from the commencement of the regulations, financial institutions shall not open or permit the operation of any account by any person or entity to conduct the business of virtual/digital assets unless that account is designated for that purpose and opened in line with the requirement of the guidelines.

Analysts’ perspectives

Commenting on the dynamics of crypto assets on price and financial stability, analysts agreed that while such online platforms have the potential to improve and democratize access to finance especially for the vulnerable population, they on the other hands pose significant concerns for regulators.

They however, pointed out that Nigeria’s current FX challenges were more of structural factors than the risks presented by cryptocurrencies.

Wealth Management and Business Development Consultant, Mr. Ibrahim Shelleng, said the government especially the monetary authorities needed to relax some of the stringent and cumbersome policies that banks currently impose for FX transfers, as a way of boosting confidence in the Naira over Binance and the likes.

He said if it becomes easier to transact via the traditional banking system and rates at par with the parallel market, then it may certainly encourage more customers to embrace the local currency, thereby helping it to appreciate against other currencies.

Shelleng told THISDAY, “In terms of its ability to provide an alternative form of FX liquidity and cross-border transactions, crypto has certainly succeeded in doing that, especially for a younger, more digitally-savvy generation. 

“Remittances to Nigeria via the Binance platform are rumoured to be in tens of billions of dollars annually, and research from Binance shows that 56 per cent of the adult population in Nigeria actively trade crypto monthly.

“Traditionally, diaspora remittances have contributed above $25 billion annually to the country’s FX position but with the emergence of platforms such as Binance, these remittances have dwindled.”

Shelleng said, “There have been recent accusations that speculators have taken hold of the Binance platform to manipulate NGN/USDT prices, which have been the benchmark for Nigerian BDCs.

“However, it would be too simple and somewhat lazy to point the finger at Binance as the cause of the FX woes. That is merely one aspect that potentially contributes but in reality, the real causes of the FX have been a combination of poor fiscal and monetary policy management in the past, which continually eroded confidence in the Naira.”

Managing Director/Chief Executive, Dignity Finance and Investment Limited, Dr. Chijioke Ekechukwu, however, doubted the assertion that Binance or trading in other crypto assets was contributing to exchange rate volatility, since much of the crypto transactions are virtual. Rather, he also attributed challenges in the FX market to corruption.

He said, “Whether you are buying or selling or paying for assets or items, the payments are mostly made virtually.

The government shouldn’t shift from the root cause of this FX crisis. The root cause is over dependence on imported goods, limited exported goods, and excess imported goods.

“We have limited revenue in foreign currency, speculation, corruption among others. The kind of political activities in the country have added to the woes of this FX market, and that is where corruption has played a major role in creating scarcity and speculative demands.”

Also speaking to THISDAY, a source who pleaded anonymity, said the key issue remained that the Naira had lost the attribute of money as a store of value, thereby enabling Nigerians with excess cash to buy either USD or crypto, rather than keep the Naira and see it deprecate in value on daily basis.

He said, “There is immediate therapy to the problem of currency crisis due to the fact that we are import dependent, limited exports, pointing out that most of crude sales receipts are impaired by either loan repayments or used to import PMS.

According to him, “Excess demand with limited supply of forex (weak CBN balance sheet) and above all endemic corruption further triggers and bolsters the BDC market. Addressing those issues is well documented.”

The source added that to fix the current situation with the local currency, the government must incentivise and boost local production for self-sustainable and exports, impose anti money laundering rules on all forex transactions, and improve hospitals to reduce medical tourism and foreign schools’ payments among others.

On his part, Managing Director/Chief Executive, SD&D Capital Management Limited, Mr. Idakolo Gbolade, said the operation of crypto assets remained a tool used by speculators to affect the constant devaluation of the Naira in conjunction with the BDCs. He called for strong and resolute regulatory interventions by the CBN.

He said the ease at which large ticket FX transactions are consummated on these platforms made it easy to be used for FX speculation.

Gbolade said, “The FX traders are using these Cryptos like Binance and the rest for the audacious assault on the Naira and without strong regulation with further worsen the position of the Naira.

“Amid the inflationary pressures occasioned by the usage of these cryptos, a strong regulatory framework needs to be put in place to ensure that they are accountable for suspicious transactions on their platforms.  

“The recent clampdown on these cryptos by the CBN has started yielding results as Naira has regained strength against the US dollar.”