Cryptocurrency Induced Systemic Risk

The Turkish lira is sharply down in value this year, over 40%. On 24 November bitcoin hit a new all-time high after the lira dropped 15% on the news of President Erdogan defending the reduction in interest rates in Turkey at a time of 20% inflation.

In Venezuela bitcoins can be used to pay for fast food, in department stores and at the airport as a reaction to the country’s hyperinflation.

On 23 November India revealed plans to ban cryptocurrencies, resulting in bitcoin’s price falling 14.8% on the major Indian exchange WazirX. Bitcoin’s price fell worldwide but not as much as in India.

The Reserve Bank of India (RBI) forced banks not to do business with crypto firms for several years until the Supreme Court overturned that policy in March 2020. The RBI continues to regard cryptocurrencies as being bad for macroeconomic and financial stability, hence reintroducing a bill to outlaw private cryptocurrencies while creating a legal framework for a CBDC.

Foreign exchange (Forex) trading is an area where central banks regard cryptocurrencies as a risk. Exchange controls are used to limit inflows and outflows of currency. If currency is turned into cryptocurrency, then these restrictions are avoided. People who chose to do this are taking big risks in the hope of making big returns. Forex trading can be volatile since money can swiftly move driven by sentiment alone.

If institutional investors start to see cryptocurrencies as useful for storing value, a way of hedging against inflation, then incidents of forex trading and the risk of high-volume capital flight increases. Central banks are concerned about consumers losing their savings, but systemic risk is even higher on their agendas.