Crypto-asset markets are fast evolving and could reach a point where they represent a threat to global financial stability due to their scale, structural vulnerabilities and increasing interconnectedness with the traditional financial system.
This is the Financial Stability Board’s (FSB’s) updated assessment of risks to financial stability from crypto-assets, published today.
The report examines developments and associated vulnerabilities relating to three segments of crypto-asset markets: unbacked crypto-assets (such as Bitcoin); stablecoins; and decentralised finance (DeFi) and crypto-asset trading platforms. It notes the close, complex and constantly evolving interrelationship between these three segments, which need to be considered holistically when assessing related financial stability risks.
The report highlights a number of vulnerabilities associated with crypto-asset markets. These include increasing linkages between crypto-asset markets and the regulated financial system; liquidity mismatch, credit and operational risks that make stablecoins susceptible to sudden and disruptive runs on their reserves, with the potential to spill over to short-term funding markets; the increased use of leverage in investment strategies; concentration risk of trading platforms; and the opacity and lack of regulatory oversight of the sector. The report also notes wider public policy concerns related to crypto-assets, such as low levels of investor and consumer understanding of crypto-assets, money laundering, cyber-crime and ransomware.
Crypto-asset market capitalisation grew by 3.5 times in 2021 to $2.6 trillion, yet crypto-assets remain a small portion of overall global financial system assets. Direct connections between crypto-assets and systemically important financial institutions and core financial markets, while growing rapidly, are limited at the present time. Nevertheless, institutional involvement in crypto-asset markets, both as investors and service providers, has grown over the last year, albeit from a low base. 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.
Although crypto-assets remain a relatively small portion of overall global financial system assets, crypto-asset market capitalisation has grown rapidly
DeFi has recently become a fast-emerging sector, providing financial services using both unbacked crypto-assets and stablecoins. Moreover, a relatively small number of crypto-asset trading platforms aggregate multiple types of services and activities, including lending and custody. Some of these platforms operate outside of a jurisdiction’s regulatory perimeter or are not in compliance with applicable laws and regulations. This presents the potential for concentration of risks, and underscores the lack of transparency on their activities.
The rapid evolution and international nature of crypto-asset markets raise the potential for regulatory gaps, fragmentation or arbitrage.
The FSB will continue to monitor developments and risks in crypto-asset markets. It will explore potential regulatory and supervisory implications of unbacked crypto-assets, including the actions FSB jurisdictions have taken, or plan to take, to address associated financial stability threats. The FSB will also continue to monitor and share information on regulatory and supervisory approaches to ensure effective implementation of its high-level recommendations for the regulation, supervision and oversight of so-called “global stablecoin” arrangements.
As the FSB highlights, the global legal and regulatory framework in relation to crypto is uncertain and in a state of constant flux. This is precisely why LawBEAM was established: to help our clients navigate the rapidly changing regulatory maze.