IMF Burst: Bitcoin is already a necessary financial instrument

Bitcoin is already a necessary financial instrument
Recently, the IMF’s stance on bitcoin has ushered in a major reversal, from the past opposition to the current support. It’s a bit confusing.

According to the IMF’s latest “A Preliminary Look at Bitcoin Cross-Border Flows” report, residents of countries with strict financial regulations are turning to Bitcoin in order to move capital more freely across borders. In countries such as Argentina and Venezuela, Bitcoin has become a necessary financial tool for preserving wealth and accessing global markets, and not just a speculative investment.

You know, in December 2023, IMF Managing Director Kristarina Georgiye said in her opening speech at an industry summit in Seoul, South Korea, that “the massive adoption of crypto assets could undermine macro-financial stability. She also said that the massive adoption of crypto assets could affect the effectiveness of monetary policy transmission, capital flow management measures, and fiscal sustainability due to tax fluctuations.

Even on April 12, the IMF asked El Salvador to change its pro-bitcoin laws. Because the law hindered El Salvador’s efforts to secure a $1.4 billion credit line.
El Salvador adopted Bitcoin as legal tender in 2021 under President Bukele. Since then, the country has invested heavily in Bitcoin, built up Bitcoin reserves, mined Bitcoin, and launched educational programs. However, the IMF opposed the Bitcoin law in loan negotiations with El Salvador, which needs more financing to pay off its debts. Negotiations have been stalled for almost two years due to the IMF’s call to limit the scope of Bitcoin in the country.

Through the content of the latest report “A Preliminary Study on the Cross-border Flow of Bitcoin”, we found that the IMF’s position on Bitcoin has undergone some changes, which can also be said to be a reversal of position, so what does it mean behind it?

The IMF’s “A Primer Look at Bitcoin’s Cross-Border Flows” report reveals how Bitcoin’s decentralized nature can be used to bypass the traditional banking system, especially in regions experiencing economic hardship or strict capital controls.

According to the IMF, residents of countries with strict financial regulations are turning to Bitcoin in order to move capital more freely across borders. “Off-chain cross-border flows appear to be linked to incentives to avoid capital flow restrictions,” the report reads.

The report highlights the high volume of transactions from countries such as Argentina and Venezuela, whose citizens face hyperinflation and strict financial regulations. In these regions, Bitcoin has become a necessary financial tool for preserving wealth and accessing global markets, not just a speculative investment.

However, the IMF report also draws attention to the potential risks of the widespread use of Bitcoin for cross-border flows. The lack of oversight and anonymity of cryptocurrencies can complicate the work of regulators to monitor and control financial transactions to prevent illegal activities such as money laundering.

The study examines on-chain and off-chain transaction data to explore the trends behind Bitcoin’s cross-border use. The study found that Bitcoin transactions are not only huge in volume, but also exhibit unique characteristics compared to traditional capital flows.

Unlike typical foreign investments, which are sensitive to economic indicators such as the strength of the currency, Bitcoin flows have a higher correlation with cryptocurrency-specific sentiment such as market volatility and user sentiment indices such as the Fear and Greed Index.

The analysis also points out that on-chain Bitcoin transactions are recorded on the blockchain, which has higher security, and their scale tends to be larger than off-chain transactions. This shows that the strong security features of blockchain technology often protect greater financial interests.
The IMF calls for international cooperation to establish a regulatory framework that covers the unique aspects of digital assets. These measures will help reduce risk while leveraging the benefits of digital currencies, especially in countries with restrictive financial conditions, as a tool to promote economic freedom.

Carbon Chain Value excerpts some of the highlights from the full report for readers’ reference. I hope to inspire and think for readers.

Since its launch in 2009, Bitcoin’s rapid growth has increased its potential macroeconomic impact. Bitcoin is the unit of account for a publicly accessible decentralized global digital ecosystem. The technological innovation behind it – a sustainable blockchain consisting of a distributed ledger that runs and exists without any trusted party. Despite the fact that Bitcoin’s price is volatile and not backed by any real assets or government claims, its price and number of active users have increased significantly over the past decade. The global nature of Bitcoin’s underlying technology means that a large portion of transactions are likely to take place across borders. However, identifying Bitcoin cross-border transactions is far from easy.

A key question is the extent to which Bitcoin is being used for cross-border transactions. The findings of this paper reveal not only the relative importance and characteristics of Bitcoin’s cross-border flows, but also its heterogeneity, especially in terms of on-chain and off-chain transactions. The use of Bitcoin for cross-border transactions is geographically very common, with relatively high levels of on-chain and off-chain movement across regions, but there are also some temporal differences due to data coverage and base estimate assumptions. By using on-chain and off-chain raw data, we can determine that the average size of on-chain transactions is much larger than that of off-chain transactions. This model may reflect the security features offered by the blockchain and the fee structure of the Bitcoin blockchain. The estimated size of cross-border Bitcoin flows is quite large compared to the GDP of some countries, especially in countries where capital flows are relatively small.

An analysis of the drivers of cross-border flows shows that the cross-border use of Bitcoin is not consistent with the factors driving capital flows, and there may be some differences between on-chain and off-chain Bitcoin cross-border flows. While the level of capital flows is not directly comparable to the estimated level of cross-border Bitcoin flows due to methodological differences, we have four important takeaways: i) Bitcoin on-chain cross-border flows react differently to traditional inflow drivers than capital flows. They appear to be negatively correlated with broad USD appreciation events, but unlike capital flows, they react positively to changes in risk aversion reflected by the VIX (Chicago Board Options Exchange Volatility Index);ii) on-chain cross-border flows are positively correlated with improvements in crypto-specific sentiment (crypto fear vs. greed)3;iii) However, neither traditional drivers of global capital flows nor sentiment towards Bitcoin affect off-chain Bitcoin cross-border flows;iv) While the role of domestic factors in cross-border and capital flows of Bitcoin is not prominent in our sample, inflation and Bitcoin-based parallel exchange rate premiums are positively correlated with on-chain and off-chain cross-border flows, respectively.

Second, we complement the small but growing literature that analyzes the drivers of cryptoassets and their relationship to traditional financial assets. Bitcoin prices are positively correlated with all intraday macro news (except CPI) and are slow to react to unexpected changes in short-term interest rates, while reacting unsteadily to news about the future policy path. Does Bitcoin hedge against global uncertainty, which is measured by the first principal component of the VIX index of 14 developed and developing equity markets. Their research shows that both the Bitcoin price reacts positively to uncertainty during both the higher orders of magnitude and shorter frequency movements of Bitcoin earnings. In contrast, there is a strong correlation between crypto asset prices and stock prices, as well as the VIX index, suggesting that crypto assets behave similarly to risky assets. Our cross-border findings suggest that Bitcoin’s on-chain flows are positively correlated with VIX (as opposed to the reaction to capital flows).

Third, by distinguishing between on-chain and off-chain flows, we provide a nuanced perspective on Bitcoin and capital flow management。 The analysis of Bitcoin’s cross-border use highlights different activities ranging from e-commerce to funds linked to illegal activities. However, unrelated to basic activities, the motivation for cross-border transfers via Bitcoin is considered to be high costs or government regulations that hinder transfers through traditional financial institutions. In this context, the role of capital controls is widely emphasized in the literature. In a recent study, underlying capital flows are still conducted through traditional channels and provide liquidity to cryptocurrency exchanges. The relative prices of crypto assets in an economy provide insightful information about the strength of demand for capital flight. The cross-border panel evidence we provide suggests that off-chain cross-border outflows are positively correlated with Bitcoin parallel premiums, which we interpret as a broader alternative to exchange rate pressures, reflecting macroeconomic imbalances that contribute to this debate.

Overall, our analysis shows that Bitcoin cross-border flows react differently to traditional drivers than capital flows. That said, we find that increased risk aversion and a stronger dollar lead to lower inflows. Unlike capital flows, analyzing capital flows reacts positively to changes in the VIX. This result is consistent with the positive correlation between VIX and Bitcoin returns, which has been widely highlighted in the literature. Chainalysis traffic is also positively correlated with cryptocurrency sentiment. While global fundamentals appear to have a limited effect on local Bitcoin flows, we find that outflows increase significantly as Bitcoin’s parallel rate premium increases.

Conclusion section

The adoption of Bitcoin has grown rapidly over the past decade. The global nature of Bitcoin raises questions about the relative importance and characteristics of Bitcoin’s cross-border flows. The sheer volume of Bitcoin transactions on and off the blockchain, and the fact that they are all anonymous, complicates the task of studying the cross-border flows facilitated by Bitcoin.

Our analysis highlights some of the differences between on-chain and off-chain Bitcoin cross-border flows. On average, cross-border on-chain transactions are much larger than off-chain transactions. Off-chain data also suggests that an increase in Bitcoin-based parallel exchange rate premium correlates with higher outflows. These findings are consistent with the numerous recent findings that Bitcoin can help circumvent capital flow constraints. As the IMF has highlighted, policymakers aiming to manage capital flows should ensure that cryptoassets are covered by capital flow management regulations. From a more structural point of view, it is of course also important to address the underlying imbalances that manifest themselves as exchange rate pressures, since the use of crypto assets is only a symptom of an imbalance.

We also found that countries with relatively large capital inflows tend to have lower Bitcoin inflows, and vice versa. In addition, Bitcoin cross-border flows react differently to traditional drivers than capital flows. On-chain money flows appear to be inversely correlated with broad USD appreciation events, but unlike capital flows, they react positively to changes in VIX. Capital flows and Bitcoin cross-border flows cannot be directly compared due to methodological differences, but we speculate that Bitcoin cross-border flows have not yet replaced existing capital flows. As a result, capital flows remain the most important quantitative channel for global risk aversion and/or escape to the peak propagation of security triggers. However, the cryptocurrency market is growing at a rapid pace. Recently, spot Bitcoin ETFs have been authorized in the US, suggesting that Bitcoin is likely to be used – even indirectly—by a growing number of mainstream financial operators. As the average user base of Bitcoin and traditional assets gets closer, the reaction of Bitcoin cross-border flows is likely to be more similar to that of traditional capital flows. Such user convergence will certainly complicate the policy response.

Since Bitcoin is a decentralized and anonymous crypto transaction technology, measuring the cross-border flow of Bitcoin is challenging and can only be achieved through a series of non-simple assumptions at the moment. While we offer a comprehensive approach to exploring on-chain and off-chain traffic to study global cross-border traffic, our dataset doesn’t capture the full extent of Bitcoin cross-border transactions. Therefore, improving the measurement of flows based on transaction-level data and determining the place of residence of on-chain and off-chain cross-border flows is key to understanding the cross-border dynamics of Bitcoin, assessing future policy needs, and designing appropriate countermeasures.

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