Ten industry bodies representing incumbent institutions and blockchain firms have written to the Basel Committee on Banking Supervision (BCBS) requesting that it revisit its standard for the treatment of crypto-assets. The biggest complaint relates to the Basel Committee’s classification of any tokenized assets issued on permissionless blockchains as high risk, with prohibitive bank capital requirements.
The ten associations (full list below) include seven representing incumbents such as the Institute of International Finance (IIF), Global Financial Markets Association (GFMA), International Capital Market Association as well as three representing blockchain firms including Global Digital Finance.
As context, the Committee finalized the standard at the end of 2022, and opened another consultation a year later. As part of that consultation, the BCBS expressed the view that banks cannot address the risks posed by permissionless blockchains, hence any tokenized securities issued on permissionless blockchains would be classified as having the same risk as cryptocurrencies. The capital required to hold cryptocurrencies makes it prohibitive for banks to hold any unless they are hedged.
In June 2024, the BCBS announced targeted amendments to the crypto standard, but stood by its view that permissionless blockchains are too risky. It subsequently published a document exploring potential paths to permissionless blockchain risk mitigation. In May 2024 the Committee delayed the implementation of the rules by a year to January 2026.
Given the BCBS considers the standard as final, the associations provide several reasons for revisiting it.
Why the BCBS should revisit the crypto standard
The international implementation of the crypto standard is inconsistent between jurisdictions or not happening in some. For example, the EU’s transitional regime doesn’t distinguish between permissioned and permissionless blockchains and so far the United States has not addressed the adoption of the standard. Hence, an improved standard might be adopted more uniformly.
Secondly, the standard is viewed as retarding the scaling of important DLT use cases that could help to address risks, including reducing counterparty risk and run risk. On the latter point, Treasuries or money market funds are often redeemed to meet margin calls, which can result in a downward price spiral during market turmoil. Using them as tokenized collateral for margin could remove the need to sell them and hence mitigate that risk.
On the other hand, some sectors are already starting to take off, such as crypto ETFs and tokenized money market funds. Non bank brokers are acting as intermediaries and non bank payment providers are using DLT for their services. The trade bodies argue that the lack of involvement of banks makes the sector riskier because banks have more stringent requirements, which raises industry standards. Plus, if more banks were involved, any remaining risks would be spread. Otherwise, a few less diversified banks tend to have very concentrated exposure to the sector. That’s an indirect nod to Silvergate Bank and Signature Bank.
Finally, they argue that market participants now have far more experience in handling DLT risks, including handling private keys using multiparty computation and permissioned smart contracts on permissionless blockchains.
While addressing the harsh treatment of tokenized assets issued on permissionless blockchains is the top priority for the associations, there are other topics they’d like to see addressed, such as hedging.
Crypto hedging
Where banks engage with cryptocurrencies, only certain types of hedging are counted as reducing a bank’s exposure. Essentially, hedging is only possible for large cryptos ($10 billion+) that also have dedicated ETN or ETFs issued. Currently the rules only allow netting of exposures on the “same market or exchange”. In the context of the collapse of FTX, one can see why the Committee included this. However, an area where banks are more likely to get involved is crypto ETFs, which is effectively an indirect exposure to crypto. This “same market or exchange” is unclear in that context.
For example, if there are two Bitcoin ETFs which are traded on the same stock exchange but each references a price at a different set of exchanges, can these exposures be netted? In other words, does the “same market or exchange” apply to the ETF or should one look through to the underlying crypto?
As this and other hedging rules reflect market and counterparty risks, the associations request that these be reviewed. They would also like to see the hedging criteria revisited.
Other Basel crypto concerns
Another issue is the amount of capital that has to be set aside for cryptocurrencies. Today Group 2 assets, mainly cryptocurrencies, have a 1250% risks weighting which in many jurisdictions means that a bank has to set aside $1 of capital for every $1 of exposure. Because of the permissionless blockchain requirements, this also applies to a bank holding a Treasury tokenized on a public blockchain. The associations want the risk weightings for the entire group to be reassessed.
Additionally, the associations want to revisit the exposure limits for banks. Cryptocurrency exposures are limited to 1% of Tier 1 capital net of hedging. The 1% can be exceeded, but it cannot go above 2%. If it goes over 2% the hedging is no longer counted which creates a steep cliff effect, because not only is there no netting, there is now double counting of long and short positions. Given the limit is 2%, presumably this cliff effect was intentional, but the associations would like it revisited.
The associations are hoping that the change in US administration might make the Committee more open to updating rules. Peter Kerstens, the architect of Europe’s MiCAR crypto regulations, recently noted that it was the United States under the previous administration – viewed as anti-crypto and anti-blockchain – that had pushed for the stringent Basel rules. However, the Committee met on 20 and 21 May and no mention was made of crypto-assets in the meeting’s report.
The letter’s authors include: Global Financial Markets Association, which brings together three financial trade associations, including the Association for Financial Markets in Europe, the Asia Securities Industry & Financial Markets Association, and the Securities Industry and Financial Markets Association; the Futures Industry Association; the Institute of International Finance; the International Swaps and Derivatives Association; the Financial Services Forum; the Bank Policy Institute; the International Capital Market Association; the Global Blockchain Business Council; Global Digital Finance; and the Crypto Council for Innovation.
