The risks from the $2.6 trillion crypto-market could quickly grow and regulators will need to have pre-prepared measures in place to bring the sector to heel, according to the Financial Stability Board (FSB), a watchdog for G20 economies that monitors risk.
The FSB stated that cryptoassets such as bitcoin are still a small part of the financial system. However, there are data gaps making it difficult to evaluate their full use, and many investors don’t understand what they’re buying.
The FSB reported that traditional finance, such as hedge funds and big banks, is also increasing in involvement, as well derivatives that refer to cryptoassets within complex investment strategies.
Financial stability risks could quickly escalate, underscoring the need for timely evaluation of possible policy solutions, the report stated in a hardening earlier FSB statements which saw crypto as posing no threat.
It stated that if the current growth trajectory in scale and interconnectedness of crypto-assets to these institutions continued, it could have consequences for global financial stability.
Regulators are increasingly concerned about the impact of a cryptoassets meltdown – highly volatile markets that remain opaque – on the wider financial system.
After China tightened crypto restrictions, there was a sharp drop in bitcoin and ether last May. Yields on U.S. and German benchmark bonds fell as investors shopped for digital tokens to protect themselves.
Jon Cunliffe, Bank of England Deputy Governor, stated in October that a collapse of cryptocurrencies was a plausible scenario.
The FSB is also promoting decentralised finance (DeFi), a cryptocurrency offshoot. This allows users to borrow, lend and save in cryptocurrency while bypassing traditional finance gatekeepers like banks and exchanges.
DeFi’s popularity has increased during the pandemic when investors are looking for yield as rock-bottom interest rates pushed them to do so. DeFi has been a magnet for frauds and other crimes, which presents additional challenges to regulators.
According to the FSB report, DeFi and its associated platforms could pose risks to financial stability if there is not enough regulation and market oversight.
Robert Ophele (chair of France’s Securities Watchdog AMF) stated last week that regulators are behind the curve. He suggested that the FSB could have its first global framework within months for stablecoins, digital asset service providers and that it might be able to do so in the coming months.
Although the FSB does not have the power to impose any binding rules, its members agree to make those principles national laws.
Although the European Union has approved a new law to regulate cryptoasset markets, regulators believe a global approach is needed due to the sector’s trans-border nature.
