Crypto assets pose mounting risk to financial stability, global watchdog warns

Regulatory gaps, fragmentation or arbitrage could ‘rapidly escalate, underscoring the need for timely and pre-emptive evaluation of possible policy responses’

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A global financial stability watchdog is raising the red flag on crypto assets, warning that they could pose a significant risk to the broader financial system if they remain outside of regulatory scrutiny.

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The Financial Stability Board (FSB) said in a Wednesday report that risks like regulatory gaps, fragmentation or arbitrage could “rapidly escalate, underscoring the need for timely and pre-emptive evaluation of possible policy responses.”

The report explored the vulnerabilities stemming from closely interrelated crypto assets such as unbacked coins (such as bitcoin), stablecoins and decentralized finance (DeFi).

The FSB took aim at stablecoins in particular, which are crypto assets that peg their worth to a commodity or currency, suggesting that their footprint has expanded significantly despite concerns surrounding regulatory compliance and the extent of reserve assets held to back them. It’s a concern that has followed stablecoin giant Tether as the company has been known to obfuscate where it stores its reserves.

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The report added that the structure of these currencies exposes them to liquidity mismatch, as well as credit and operational risks, putting them at greater risk of disruptive runs on their reserves. Stablecoins in particular currently serve as a bridge between traditional fiat currencies and cryptocurrencies.

The Tether application on a smartphone.
The Tether application on a smartphone. Photo by Tiffany Hagler-Geard/Bloomberg

“Were a major stablecoin to fail, it is possible that liquidity within the broader crypto-asset ecosystem (including in DeFi) could become constrained, disrupting trading and potentially causing stress in those markets,” the report read. “This could also spill over to short-term funding markets if stablecoin reserve holdings were liquidated in a disorderly fashion.”

These concerns come as the crypto asset market cap grew 3.5-fold to US$2.6 trillion in 2021. Banks and financial institutions crucial to system stability are also increasing their exposure to cryptocurrencies as they adopt them into their business models through products ranging from exchange-traded funds to complex derivatives and other leveraged investment products, according to the FSB.

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“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 read.

This report comes as Canada is enhancing scrutiny of cryptocurrency transactions through new measures introduced as part of the federal government’s Emergencies Act, which was invoked Monday in response to blockades that have snarled trade with the U.S. at several border crossings.

Cryptocurrency scams have also given market watchers cause for concern. A report from crypto analytics firm Chainalysis report found that crypto rug-pull scams raked in over US$2.8 billion in illicit activity last year.

The FSB added that it would continue to monitor these assets and ensure recommendations are followed through on to grant assets proper oversight.

Financial Post

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