IMF director: There’s a ‘fundamental clash’ between crypto and financial institutions

IMF’s Director of Monetary and Capital Markets Tobias Adrian joins Yahoo Finance Live to discuss the Fed’s policy pathway, crypto regulation, and the expectations for the economy.

Video Transcript

JENNIFER SCHONBERGER: Well, with the Federal Reserve slowing down the pace of rate hikes, that's, perhaps, contributing to the rebound we've seen so far this year in crypto. I decided to check in with Tobias Adrian, director of capital markets and global monetary policy at the International Monetary Fund to get his take on crypto and monetary policy. We kicked off the conversation asking about whether the Fed's current policy path to raise rates to a peak of 5 to 5 and 1/4% makes sense given that financial conditions have started to re-tighten, and the market is now more aligned with the Fed. Take a listen.

TOBIAS ADRIAN: We came out with our forecast for the global economy but also for individual countries, including the US, just about three weeks ago. And we do see a decline in inflation later this year. We do see a bottoming out of activity. But our forecast is much closer to what the Fed had forecast rather than the much more optimistic forecast that was embedded in markets.

JENNIFER SCHONBERGER: I want to ask you what Fed policy monetary policy means for crypto. Clearly, the Fed has signaled that it's not going to cut rates this year, really wants to avoid the scenario of the 1970s when inflation resurged. And they had to go back in and hike rates further. What do you think this means for the crypto outlook? Does the winter continue? Or given that the Fed is beginning to slow the pace of rate hikes and looks like it could hold at some point here later this spring or summer. Does that offer some optimism for the crypto space?

TOBIAS ADRIAN: Well, winter implies that there's spring and summer one day. But it's not entirely clear that we will go back to the kind of valuations that we saw in the past, right? I think there is like, a realization that some of the structures that were out there don't work. A number of products just imploded, right, that they didn't work, was a surprise valuations. And cryptos went down. And so that is one fundamental challenge.

The second fundamental challenge is that, of course, the regulatory landscape is changing, right? I mean, there's a concerted effort by regulators around the world led by the FSB, the Financial Stability Board, which is also housed in Basel to have a comprehensive, coordinated, and coherent regulation for crypto around the world. We've seen some elements of that already. The Basel Committee came out with capital requirements for banks holding unbacked crypto assets. And those are very, very high requirements. So because the sector is viewed as being somewhat risky.

And then, of course, around the world, everybody is watching what is happening with stablecoins. What stablecoin regulations are going to be. And most recently in the US, of course, the Fed didn't provide access to its system to some of those stablecoin providers. So that is also very much at the forefront of policy at the moment.

JENNIFER SCHONBERGER: But our investors still vulnerable to some sort of major bankruptcy or collapse in the crypto space at this point.

TOBIAS ADRIAN: That is very difficult to exclude, right, because the majority of products are not regulated in the way in which traditional financial institutions are regulated, right? I mean, there's very little prudential regulation. There's very little investor protection. There's very little assurances of how a customer assets are being-- are being dealt with. And, you know, how many entities are operating out of offshore jurisdictions. So they might not have the same protections that you would have if these entities were based in the US. So it's difficult to exclude that we couldn't see further disruptions, collapses, or worse.

JENNIFER SCHONBERGER: Mm-hmm. And you mentioned the Fed turning down crypto bank Custodia's application to become a member of the Federal Reserve System. As part of that, they came out with a policy statement a couple of weeks ago trying to make clear that both uninsured and insured financial institutions are both subject to the same limits when it comes to crypto, namely, that banks cannot hold crypto as principal on their balance sheet. But they may act as custodians. Do you think that the Fed is trying to box crypto out from coming into the traditional financial system?

TOBIAS ADRIAN: Right, it's a certain degree of making sure that the banks are not so like, exposed to risks that are very difficult to control. One of the things-- one of the deciding factors that the Fed cited in some of those decisions was the difficulty to enforce anti-money laundering laws, right? I mean, you must be able as an institution to make sure that what's going on is legal, right? And that is very difficult to do in a world where transactions are fundamentally anonymous.

And so that's a fundamental clash in between traditional banking regulatory approaches and the crypto world. And it's-- I think regulators will not be at ease unless there's a solution to this anti-money laundering and terrorist financing problem. So basically making sure that-- so banks spend a lot of resources making sure that their transactions are legal, right? And that is just fundamentally at odds with the design of crypto.

JENNIFER SCHONBERGER: And our special thanks to Tobias Adrian, director of Capital Markets and Monetary Policy at the IMF.