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BIS says approach to crypto risks is to ban, contain or regulate it

BIS crypto-assets ban contain regulate

The Bank for International Settlements (BIS) published a brief paper exploring the options to address the risk of cryptocurrencies, or as it likes to call them, crypto-assets.

It argues that cryptocurrencies feature many of the risks of TradFi, but while similar, the risks tend to be exaggerated. These include the extensive use of leverage, liquidity and maturity mismatches, and significant asymmetries in information.

We’d add an observation on the maturity mismatches. For example, crypto lenders have deposits that can be instantly withdrawn but extend loans to borrowers for months or years. TradFi may have similar mismatches. However, because cryptocurrency is networked, including at the social/Twitter level, ‘bank runs’ and herd movements are far more frequent, exaggerating the problematic nature of the maturity mismatches.

The BIS report highlights that DeFi often is not decentralized because founders have significant token stakes or others can acquire major influence. It also points to the critical roles of centralized cryptocurrency exchanges as crypto onramps. Another observation we have is that decentralized wallets increasingly enable direct onramps using credit cards which over time may partially erode the onramp role of exchanges.

Four ways to address crypto risks

While the BIS report highlights three routes that directly address crypto risks, the report also mentions a fourth. That’s to make TradeFi more attractive by reducing the cost of payments or through central bank digital currency (CBDC). However, we’d argue that payments is just one application, although it’s understandable that it’s the one most on the radar for the central bank community.

The three direct routes to control crypto risks are to ban, contain, or regulate it. 

The BIS recognizes that banning it may not be acceptable for free societies. Also, bans can be circumvented and it could inhibit innovation.

By containing crypto the BIS means ringfencing crypto, so the minimal overlap with TradFi is maintained. As an example of containment, the BIS cites the Basel Committee crypto rules for banks – the final version was announced in December. Another example is the SEC’s refusal to allow a spot Bitcoin ETF. However, even if TradFi is ringfenced, there’s still the issue of investor protection. And the BIS notes the risk that the credibility of regulators could be undermined if no action is taken to protect crypto invetors.

And that action is likely to be regulation. A common approach is mapping crypto activities to conventional activities to apply the same risks and rules. But the mapping is not always straight forward. For example, some jurisdictions will regulate stablecoin issuers as banks, some as payment systems and others as banks. A second challenge is identifying the entity in a decentralized world. However, it sees the starting point as the entity that has control over the protocol.

With the crypto crash, particularly the collapse of FTX, the crypto community is braced for extensive regulation. However, politicians may not always be as conservative as central bankers. For example, in the UK, this week the Treasury emphasized that it wants to balance innovation with investor protection and avoid “foreclosing on the future.”

Image Copyright: BIS