The booming crypto assets market could pose a serious threat to financial stability if regulators fail to take action, a global watchdog has said.
The Financial Stability Board (FSB), which monitors financial authorities in 24 countries, is concerned that the scale and structural vulnerabilities of crypto markets – as well as increasing interconnectedness with traditional financial systems – have the potential to cause significant disturbance to the global economy.
“Although the extent and nature of use of crypto assets varies somewhat across jurisdictions, financial stability risks could rapidly escalate, underscoring the need for timely and pre-emptive evaluation of possible policy responses,” the Swiss-based body said in a report.
“Systemically important banks and other financial institutions are increasingly willing to undertake activities in, and gain exposures to, crypto assets. The prevalence of more complex investment strategies, including through derivatives and other leveraged products that reference crypto assets, also has increased.
“If the current trajectory of growth in scale and interconnectedness of crypto assets to these institutions were to continue, this could have implications for global financial stability.”
The report estimated that crypto asset market capitalization grew 3.5 times in 2021 to a value of $2.6tn (£1.9tn). It noted that crypto assets remain a small part of the overall financial system, but likened the risk to the sub-prime mortgage exposure that sparked the financial crisis of 2007-8.
“If financial institutions continue to become more involved in crypto asset markets, this could affect their balance sheets and liquidity in unexpected ways,” the FSB continued.
“As in the case of the US sub-prime mortgage crisis, a small amount of known exposure does not necessarily mean a small amount of risk, particularly if there exists a lack of transparency and insufficient regulatory coverage.”
The report examined the vulnerabilities of three aspects of crypto assets markets, including unbacked currencies such as bitcoin; stablecoins such as tether, which is backed by reserve assets; decentralized finance (DeFi) and crypto asset trading platforms. All exist online only and are not regulated by a centralized body.
Of particular concern is the structure of stablecoins, which leaves consumers vulnerable to high credit and operational risks, liquidity mismatch and sudden runs on their reserves. Unbacked currency also carries the risk of high price volatility. Other concerns include the environmental impact of energy-sucking mechanisms used for certain crypto assets, as well as public policy issues, such as its use for money laundering, ransomware and cybercrime.
The FSB has no binding regulatory jurisdiction over countries, but rather monitors the financial system and advises policymakers on best practice. Among its members is the Bank of England governor, Andrew Bailey. Regulators including the Financial Conduct Authority have previously warned over the risks in buying cryptocurrencies, such as ones promoted by celebrity influencers including Kim Kardashian West.
The FSB promised to continue to monitor developments and risks in the crypto asset markets, as well as explore the supervisory implications of unbacked assets, in order to help member states address the associated threats to financial stability.
“Given the international and diverse nature of the crypto asset markets, authorities globally [need to] prioritizes cross-border and cross-sectoral cooperation,” the report concluded.
“Efforts to enhance monitoring and to minimize regulatory arbitration through further cooperation and information sharing are needed to keep pace with crypto asset developments.”