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Fitch Ratings, a global credit rating agency since 1913, shared views on the new cryptocurrency industry.
Alastair Sewell(Head of Fund and Asset Manager Group for EMEA and APAC) and Monsur Hussain(Head of Financial Institutions Research) are senior directors in Fitch ratings’ financial institutions rating group. Alastair’s primary responsibility is rating mutual funds; his interest in stablecoins relates to the composition and management of their reserve portfolios. Monsur is responsible for global financial institutions thematic research, and has had a long-standing interest in regulation and digitalisation topics.
Through the perspective of Fitch Ratings, Tokenpost look into the present and future of the cryptocurrency industry.
▲Alastair Sewell(left), Monsur Hussain(right)
Q. Please introduce your company.
Fitch Ratings is a leading provider of credit ratings, commentary and research. Dedicated to providing you value beyond the rating through independent and prospective credit opinions, Fitch Ratings offers global perspectives shaped by strong local market experience and credit market expertise. The additional context, perspective and insights we provide have helped fund a century of growth and enables you to make important credit judgments with confidence.
Q. Fitch Ratings released a report on the El Salvador’s Bitcoin adoption and on stablecoins. What made the global credit rating agency look into the cryptocurrency industry? I wonder if you think cryptocurrency has a role in the financial market. How do you think the cryptocurrency market will affect the existing financial sector?
Fitch’s vision is to be the best rating agency. To achieve this vision, Fitch must be on the leading edge of new market developments. The technologies underpinning the cryptocurrency market may, eventually, alter the competitive landscape of the financial sector. Accordingly, Fitch has dedicated significant resources to understanding the cryptocurrency sector and identifying associated risks.
Financial market participants already show broad acceptance of digital finance technologies. For example, significant efforts are under way to use blockchain based methods to facilitate bond trades. After a slow start, regulators too are now quite advanced in their consideration of the treatment of the digital finance sector and cryptocurrencies. It therefore appears that cryptocurrencies will have a place in the future of finance.
A key consideration is the interaction between digital finance markets and traditional finance markets, and the risk of spill-over effects from digital finance to traditional finance. For example, a severe price shock affecting cryptocurrencies, or a mass redemption of stablecoins that could pressure underlying short-term securities markets. Or, criminal activity in the cryptocurrency sector affecting traditional finance markets through linkages such as exchanges facilitating digital-public currency interactions, or cases of fraud.
Q. Your report says that the El Salvador’s decision could weaken insurance companies. What do you think are the positive and negative effects of the country's Bitcoin adoption?
The move to formally adopt bitcoin is a way for Salvadorans to gain access to more payment methods, given that more than three-quarters of the population are unbanked. We note that the government’s roll-out of the Chivo Wallet app was boosted by rewards of $30 worth of bitcoin. Access to bitcoin provides a means of financial inclusion for those considered too risky to be supported by the traditional financial industry. The use of bitcoin could also be highly useful in facilitating remittance payments from Salvadorans working abroad.
However, we believe that the high level of bitcoin price volatility will challenge its use as a store of value and means of payment. And, should citizens decide that they want their salaries to be paid in bitcoin, which is now an option available to them, their monthly incomes could experience massive fluctuations from month to month.
Fitch does not expect bitcoin to be widely used by insurers to make claim or benefit payments or insurance companies to offer policies denominated in the digital currency. Insurers will likely convert bitcoin into USD as quickly as possible to limit exchange risks, if policyholders decide to use it to pay premiums. Insurers that hold bitcoin on their balance sheets for extended periods will be acutely exposed to its price volatility, increasing asset risk, which is a credit negative.
Bitcoin’s lack of transparency could increase the risk of money laundering if regulations do not fully comply with Financial Action Task Force (FATF) standards. Foreign correspondent banks could require more detailed due diligence and checks on El Salvador's financial institutions if regulations and controls are not robust enough to avoid tax evasion, money laundering and terrorist financing.
Q. How do you evaluate large cryptocurrencies such as Bitcoin, Ethereum, and Ripple as financial assets?
Fitch would typically treat cryptocurrency exposures as high risk investments in its analysis of entities’ balance sheets. Cryptocurrencies have demonstrated material price volatility and may be exposed to elevated KYC and AML risks. In addition, the gap in legal and regulatory characterisation of cryptocurrencies in major jurisdictions contributes to weaker investor protection regarding the distribution and trading of cryptocurrencies.
Q. I wonder how you foresee the future of the cryptocurrency market? What factors do you think will affect the outlook?
Cryptocurrencies appear increasingly established and have now achieved scale. The recent authorisation of cryptocurrency-based ETFs in major fund domiciles such as the US and Australia, combined with growing regulatory clarity on cryptocurrencies suggests they will persist as part of the financial system. However, as China has demonstrated, regulation may change materially, potentially limiting the future for cryptocurrencies, or altering their key use cases. History shows that private money has not persisted for prolonged periods of time, ultimately being phased out in favour of sovereign money. The extent to which jurisdictions adopt CBDCs may therefore become an important determinant of the future of the private cryptocurrency sector.
DeFi builds financial services as software, and has the potential to recreate the entire ecosystem of finance using novel technical foundations, across borders internationally. Though decentralised finance is still in the beginning stages of its evolution, the total value locked into DeFi of various types (collateral pools, DeFi smart contracts/protocols) in leading platforms such as Maker, Compound, Uniswap and Aave has grown very fast. Although existing regulations should apply to DeFi, the fragmented and decentralised nature of the platforms makes it very difficult for national legal, taxation, and regulatory regimes to be applied that have been developed around traditional centralised financial systems. We expect regulators may have to fundamentally rethink their approach to provide coordinated guidelines to ensure adequate investor protection and legal certainty, while promoting market integrity and financial stability.
Stablecoins may ultimately have greater acceptance by end-users and regulators, than other cryptocurrencies. Again, however, much will depend on regulatory treatment of stablecoin issuers and the composition of their reserve assets, and changes stablecoins make to their operating arrangements in response to actual or anticipated regulatory change. Current regulatory focus appears to increasingly favour the treatment of stablecoins issuers as banks, which could have material consequences for their capital structure and reserve portfolio composition, among other factors.
