The fast-evolving crypto markets could gravely threaten global financial stability if regulators fail to take action, according to the Financial Stability Board (FSB), an international watchdog.
In a report published on February 16, the FSB, which monitors financial authorities in 24 nations, reviewed potential vulnerabilities pertaining to unbacked crypto assets such as bitcoins, stablecoins as well as decentralised finance (DeFi) along with crypto trading platforms.
The global watchdog, in its report, expressed concern that the scale and structural vulnerabilities of crypto markets in addition to increasing interconnectedness with traditional financial systems may cause substantial disturbance to the global economy.
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“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 report noted.
“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,” it added.
The report further stated that “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 assessed that crypto asset market capitalisation rose 3.5 times in 2021 to a value of $2.6 trillion. It said that crypto assets continue to remain a minor part of the entire financial system, but equated the risk to the sub-prime mortgage exposure that triggered 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 report stated.
As in the case of the US subprime 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, it noted.
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The report reviewed the vulnerabilities of three segments of crypto assets markets, comprising unbacked currencies of the likes of bitcoin, stablecoins such as tether, that are backed by reserve assets, crypto asset trading platforms, and decentralised finance (DeFi). All these exist online only and are not monitored by a centralised body.
The structure of stablecoins is of particular concern as it renders consumers susceptible to high credit as well as operational risks, sudden runs on their reserves and liquidity mismatch.
Unbacked currency also entails a risk of high price volatility. Additional concerns comprise the environmental impact of energy-intensive mechanisms used for certain crypto assets, public policy issues like its use for cybercrime, ransomware, and money laundering.
The FSB stated that it will continue to monitor developments and risks in crypto-asset markets, including with respect to crypto-asset trading platforms, based on the framework published in 2018.
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