The Bank of England is concerned that unregulated crypto growth could end with major price correction with far-ranging consequences.
“There are well-founded concerns around crypto assets in relation to investor protection, market integrity and financial crime” that could have implications to financial stability, said Sir Jon Cunliffe, deputy governor of financial stability at the $959 billion Bank of England and chairman of the Bank for International Settlements’ Committee on Payments and Market Infrastructures (CPMI). Cunliffe voiced his concerns at the Sibos 2021 conference on Wednesday.
Cunliffe noted that the price of Bitcoin has dropped precipitously by more than 10% in a single day “on nearly 30 occasions in the past five years,” the largest such drop being a 40% plunge. “Such major corrections have been relatively frequent in the short life of crypto assets,” he said.
While crypto investment is still largely made by consumers, banks are now offering or planning to offer digital asset custody and trading as well as investment services, while others like Bank of America are studying the possibilities.
Credit card and other payment companies are working to allow consumers and businesses to use stablecoins ― cryptocurrencies backed by assets such as fiat currencies ― or other crypto for payments and other transactions, and more complex investment strategies, like crypto futures, are emerging.
Concerns
The question about cryptocurrency, Cunliffe said, is what the implications for global financial stability are “if crypto assets continue to grow and scale and continue to become more integrated into the traditional financial sector, and if investment strategies continue to become more complex.” The worry is not that investors could lose large amounts of money, but the goal should be to ensure the financial system is resilient enough to sustain any crypto price correction, he added.
He gave two examples of major price corrections: the dot-com crash of the early 2000s, when investors lost more than $5 trillion, and “the collapse of the $1.2 trillion market in subprime mortgage-backed securities in 2008” that triggered the Great Recession.
“In that case, the knock-on effect of a price collapse in a relatively small market was amplified and reverberated through an unresilient financial system, causing huge and persistent economic damage,” Cunliffe said.
An extreme scenario
Cunliffe considered an “extreme” scenario if the price of unbacked crypto assets were to fall to zero, saying: “Such a collapse is certainly a plausible scenario, given the lack of intrinsic value, the price volatility, the probability of contagion between crypto assets, the cyber and operational vulnerabilities and, of course, the power of herd behavior.”
The result would depend on how the assets in question are integrated into the financial system and the resilience of the system at the time ― and there could also be secondary or indirect effects.
“For example, a severe fall in the value of crypto assets could trigger margin calls from crypto positions, forcing leveraged investors to find cash to meet them, leading to the sale of other assets and generating spillovers into other markets,” Cunliffe said. “Or investor sentiment could be affected more broadly, where investors could sell off other assets they judge risky.”
Cunliffe said he believes a severe price correction in crypto wouldn’t cause financial stability problems, but “the current trajectory implies that this may not be the case for very long.”
Regulation needed
Regulatory authorities must ensure that stablecoin and other crypto payment systems meet standards for systemic payment systems, Cunliffe said, but applying “same risk, same regulation” standards of traditional payment systems to stablecoins and other crypto technology poses challenges.
Cunliffe referenced a report that CPMI and the International Organization of Securities Commissions issued Oct. 6, providing guidance on how the principles of financial market infrastructures apply to stablecoin payment schemes.
“An important element of the guidance … makes clear that a stablecoin scheme needs to be governed by a discrete legal entity with accountability for the operation of the scheme and for the management of risk,” Cunliffe explained. “A decentralized crypto algorithm on the internet will clearly fail this requirement.”
However, risks can be managed in crypto just as they are in traditional finance, he said.
“Bringing the crypto world effectively within the regulatory perimeter will help ensure that the potentially very large benefits of the application of this technology to finance can flourish in a sustainable and safe way,” Cunliffe concluded. He is not alone in looking for regulation.
“As [Securities and Exchange Commission Chairman Gary Gensler] has observed, financial innovations throughout history do not flourish outside public policy frameworks,” Cunliffe said.
