Crypto Assets Pose Growing Risk to Global Financial Stability, Report Warns

Regulatory gaps, fragmentation or arbitrage could ‘escalate rapidly, highlighting the need for early and preemptive assessment of possible policy responses’

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

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The Financial Stability Board (FSB) said in a report on Wednesday that risks such as regulatory gaps, fragmentation or arbitrage could “aggravate rapidly, underscoring the need for early and preemptive assessment of possible policy responses. “.

The report explored vulnerabilities resulting from closely related crypto assets such as unbacked coins (like bitcoin), stablecoins, and decentralized finance (DeFi).

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

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

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

“Should a major stablecoin fail, it is possible that liquidity within the broader crypto-asset ecosystem (including in DeFi) will become constrained, disrupting trade and potentially causing stress in these markets,” the report said. . “It could also spill over into short-term funding markets if stablecoin reserves are liquidated in a disorderly fashion.”

These concerns come as the market capitalization of crypto assets has increased 3.5 times to reach US$2.6 trillion in 2021. Banks and financial institutions critical to the stability of the system are also increasing their exposure to cryptocurrencies adopting 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 the scale and interconnection of crypto-assets with these institutions were to continue, it could have implications for global financial stability,” the report states.

The report comes as Canada steps up scrutiny of cryptocurrency transactions through new measures introduced under the federal government’s Emergency Measures Act, which was invoked on Monday in response to lockdowns that have hampered trade with the United States at several border crossings.

Cryptocurrency scams have also raised concerns among market watchers. A report by crypto analytics firm Chainalysis Report revealed that crypto mat pulling scams netted over US$2.8 billion in illicit activity last year.

The FSB added that it would continue to monitor these assets and ensure recommendations were acted upon to grant proper oversight of the assets.

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