Capital markets News

Financial Stability Board worried about institutional exposure to crypto-assets

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Today the Financial Stability Board published a report on crypto-assets that warns of the potential risks to the global financial system. The concerns are linked to the rapid evolution of crypto, the scale, structural vulnerabilities and increasing connectedness with the traditional financial system. While it has concerns about all these issues, it’s particularly concerned about the impact on the current mainstream systems.

Risks were split into three areas, un-backed crypto-assets such as Bitcoin, stablecoins, and Decentralized Finance (DeFi) and crypto trading platforms. In each area, it considered the risks of financial sector exposure, wealth effects, and confidence effects. 

For DeFi and crypto trading platforms, a major risk is the increasing amount of centralized activity on a small number of cryptocurrency exchange and lending platforms, which tend to operate in offshore jurisdictions. It’s the concentration, the mix of functionality combining lending and custody, and the lack of regulatory oversight and transparency which is triggering these concerns.

While blockchain may provide transparency, these centralized exchanges often conduct transactions off-chain. Combined with the lack of regulatory oversight, it’s difficult for regulators to see what’s happening.

Incumbent exposure is key concern

The paper lists eight areas where there should be ‘ongoing vigilance’. The top three items relate to an increasing interconnectedness of crypto-asset markets with incumbent financial institutions. Number one is increased bank sector involvement, particularly if balance sheet exposure is not properly captured. Second is institutional investors increasing exposures, especially if leverage or derivatives are involved. And third is if the current low level of adoption for mainstream payments suddenly increases.

Although the report covers DeFi, the impression is that this is likely to be more problematic in future. However, it noted that DeFi value locked at the end of 2021 surpassed $100 billion. 

“In an extreme case, where a DeFi platform is completely decentralised, there may be no single person or entity that could be held responsible for the functioning of the protocol (even though this may not be the case in the current generation of decentralised governance arrangements),” states the report.

Meanwhile, one of the FSB’s formal actions is to address the threats of so-called global stablecoins. It’s conceivable this might be viewed as less urgent because Diem – the stablecoin founded by Facebook – recognized it was never going to get the go-ahead and sold its technology to Silvergate Bank.