This browser is not actively supported anymore. For the best passle experience, we strongly recommend you upgrade your browser.
THE LENS
Digital developments in focus
| 2 minutes read

Cryptoassets and financial stability: BoE outlines key risks and approach

In a new report published last week, the Financial Policy Committee (FPC) of the Bank of England began formalising its position on the risks to financial stability posed by the increasing size of the cryptoassets market. The FPC concludes that while crypto currently represents only a limited risk, they nevertheless merit formal risk-monitoring given their recent growth and the stated ambition of some cryptoassets (most notably stablecoins) to compete with the traditional financial sector.

The FPC identified four key “risk channels” and indicated that its near-term focus will be to establish appropriate transparency and monitoring of key-risk indicators in respect of each:

  • Risks to systemic financial institutions:  The direct involvement of banks and insurers in the cryptoasset markets is currently limited and unlikely to represent a significant risk. However, several banks are planning to offer cryptoasset market-making activities and cryptoasset custody services. The former will instigate a growth in direct exposure to cryptoassets whereas the latter means the banks will need to manage new operational risks. In addition, stablecoins could eventually emerge as an alternative to commercial bank deposits. 
  • Risks to core financial markets: Cryptoassets currently form only a small fraction of institutional investment portfolios. Cryptoasset derivatives traded on regulated markets represent a potential liquidity risk due to their high volatility, however spillover of such risk into broader financial system remains unlikely as long as cryptoasset derivatives represent only a small proportion of traded assets. Additionally, some stablecoins hold backing assets significantly less liquid than cash, which could make them vulnerable to mass redemptions.
  • Risks to the ability to make payments: While cryptoassets (in particular stablecoins) do not yet play an important role in payments, this could change in the future. The FPC reminds that it had set out specific expectations for stablecoins (also restated in the annex to the report) used in systemic payment chains, which should be regulated to deliver the same level of confidence as commercial bank money.
  • Impact on real economy balance sheets. Although retail investment has seen significant growth recently, the retail and business investment in cryptoassets still represents only a small fraction of UK net financial wealth and the risk it represents to financial stability is accordingly limited.

Particularly noteworthy is the FPC’s interest in stablecoins, which have the most potential for wider use and increasing interlinkages and competition with the traditional financial sector. In this regard, the report indicates that the FPC’s scrutiny will be centred on the composition and liquidity of the stablecoins’ backing assets and that it will pay careful attention to any stablecoins which form part of systemic payment chains.

The report also confirms that the approach to further regulation of cryptoassets will be two-pronged: where crypto technology performs (or could perform in the future) a similar economic function as the traditional financial sector (as is the case with stablecoins), the scope of existing regulatory framework should to be expanded to apply to cryptoassets; in other areas, a separate regulatory framework for cryptoassets will likely be required.

Overall, the report is yet another signal that cryptoassets are increasingly moving from the regulatory ‘grey area’ just outside the edge of the regulatory perimeter into the spotlight of regulatory focus. The report formalises the view already held by many that the urgency with which regulators will approach supervision of cryptoassets will derive directly from the growth of cryptoasset market and its potential for competition with the traditional financial sector.

For other related news, please see also a post by my colleague, Tim Fosh, on the PRA's recent letter on cryptoasset exposures. 

The FPC is of the view that as cryptoassets and DeFi grow and develop, enhanced regulatory and law enforcement frameworks are needed, both domestically and at a global level. These frameworks should address developments in cryptoasset markets and activities, to encourage sustainable innovation, and maintain broader trust and integrity in the financial system.

Tags

cryptoassets, fig

Latest Insights