Crypto Threat to Financial Stability Could 'Escalate'
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Crypto Threat to Financial Stability Could 'Escalate'

Created 2yr ago, last updated 2yr ago

The Financial Stability Board says digital assets are being increasingly interconnected with traditional systems — meaning episodes of price volatility could spill over into the markets.

Crypto Threat to Financial Stability Could 'Escalate'

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The threat that cryptocurrencies pose to global financial stability could "rapidly escalate," a new report has warned.

The Financial Stability Board says digital assets are being increasingly interconnected with traditional systems — meaning episodes of price volatility could spill over into the markets.

Institutions are increasingly gaining exposure to virtual currencies too, and the use of "complex investment strategies" such as leverage is on the rise. The authors wrote:

"If the current trajectory of growth in scale and interconnectedness of cryptoassets to these institutions were to continue, this could have implications for global financial stability."

According to the FSB, the risks don't end here given as there is a low level of understanding surrounding how cryptocurrencies work among consumers — "and uncertainties around the operational resilience of some cryptoasset-focused institutions."

In compiling the report, the FSB sought to examine the three key segments of the crypto markets: unbacked assets such as Bitcoin, stablecoins, and trading platforms including decentralized finance protocols.

The authors warned that stablecoins are "susceptible to sudden and disruptive runs on their reserves" — and to make matters worse, some issuers have failed to prove that coins in circulation are fully backed by dollars sitting in a bank.

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'Areas for Ongoing Vigilance'

The FSB concluded its report by warning that global regulators need to keep a close eye on the "acceleration in adoption of cryptoassets for payments" — as established payment firms, retailers and social networks look for opportunities in the space. (PayPal already allows crypto to be used as a payment method with merchants, while Visa and Mastercard are also getting increasingly involved in the space.)

Another area of concern relates to differing regulatory approaches around the world — as "potential systemic risks" could emerge when tough measures in one jurisdiction are played off against lax rules in another.

Looking forward, the FSB is calling on the authorities to "prioritize cross-border and cross-sectoral cooperation" given "the international and diverse nature of the cryptoasset markets."

The report echoes warnings given by the Bank of England's deputy governor last October.

In a speech, Sir Jon Cunliffe said a "massive collapse" in cryptocurrency prices was a "plausible scenario" — and that, at one point in the future, this could destabilize some of the world's biggest economies.

He pointed to how the subprime mortgage market, which triggered the 2007-08 financial crisis, was valued at about $1.2 trillion at the time of its collapse. By contrast, the total market capitalization of all cryptocurrencies stood at $2.3 trillion at the time of his speech.

Sir Jon did stress that regulators shouldn't classify new technologies as "dangerous simply because they are different" — and acknowledged that crypto can deliver "radical improvements in financial services."

But he also expressed fears about the levels of leverage used in this largely unregulated space, and the number of coins in circulation that have "no intrinsic value and are vulnerable to major price corrections."

Central banks and regulators have been struggling to keep up with the fast-moving world of crypto — not least because of how decentralized it is.

Crypto advocates are often vocally dismissive of warnings like those given by the FSB, with some alleging that these bodies are acting in their own self-interest because they would be rendered obsolete if the importance of fiat diminishes.

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