The deputy governor of the Bank of England, Jon Cunliffe, has called for regulators to make haste in setting standard rules for cryptocurrency markets.
"Regulators internationally and in many jurisdictions have begun the work. It needs to be pursued as a matter of urgency," Cunliffe said in a speech to the SIBOS (formerly the SWIFT International Banking Operations Seminar) conference.
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Cryptoassets have grown by roughly 200% in 2021, from just under $800bn to $2.3trn today, Cunliffe noted in his speech.
“When something in the financial system is growing very fast, and growing in largely unregulated space, financial stability authorities have to sit up and take notice,” Cunliffe declared while cautioning that regulators should be careful of overreacting, particularly when faced with the unfamiliar.
Cunliffe said crypto technologies offer a prospect of radical improvements in financial services but their current applications are now a financial stability concern for a number of reasons.
The Bank of England bigwig said most cryptocurrency assets have no intrinsic value and are vulnerable to major price corrections. He noted that price movements of Bitcoin – the best-known cryptocurrency – have “been twelve times more pronounced than that of the S&P500”.
The SIBOS audience was told that the financial stability risks of cryptocurrency markets are currently relatively limited “but they could grow very rapidly” as the big players in traditional financial markets move in and take over from the geeks and nerds punting a few hundred dollars here and there on cryptocurrencies.
“This is happening in largely unregulated space,” Cunliffe warned.
Jon Cunliffe looks at the impact of ‘crypto’ on the stability of the UK’s financial system. And he talks about how regulators are responding to their rapid growth. https://t.co/8QNbeF3qqY pic.twitter.com/j6nRW2WAf6
— Bank of England (@bankofengland) October 13, 2021
“How large those risks could grow will depend in no small part on the nature and on the speed of the response by regulatory and supervisory authorities,” Cunliffe told the attendees at the annual banking conference.
Cunliffe cited the bursting of the dotcom bubble at the turn of the century and the financial crash in the first decade of the new century as two different examples of the potential knock-on effects of a collapse in one sector of the market on the economy as a whole.
In the case of the dot.com crash, the losses for investors were material but there was no loss of financial stability.
“By contrast, the collapse of the $1.2 trillion market in sub-prime mortgage-backed securities in 2008 triggered the great financial crisis. In that case, the knock-on effects of a price collapse in a relatively small market was amplified and reverberated through an un-resilient financial system causing huge and persistent economic damage,” Cunliffe said.
“Whether a major price correction is absorbed by the system, admittedly leaving some investors with very sore heads or whether it is amplified into a systemic impact depends on a number of key characteristics of how the asset is integrated into the financial system, especially interconnectedness and leverage. It depends also on the resilience of the system at the time of the correction – the liquidity in the system under stress and the ability of core elements of the system to absorb any losses.
“So a necessary thought experiment from a financial stability perspective is what would happen in the financial system if there was a massive collapse in the price of unbacked cryptoassets – at the extreme end, if the price fell to zero,” Cunliffe said.
Such a collapse is “certainly a plausible scenario”, Cunliffe claimed.
The BOE’s deputy governor restated his belief that the price volatility of unbacked crypto-assets makes them unsuitable for use as a settlement asset in payment systems.
“In order to facilitate payments in crypto-assets, a number of crypto-asset models have emerged that are denominated in fiat money and backed with a pool of assets. The asset pool is intended to stabilise the value of the crypto-asset or ‘coin’ relative to the fiat peg – hence the name ‘stablecoins’,” Cunliffe said.
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Applying this principle of ‘same risk, same regulation’ to systemic payment systems based on stablecoins and crypto technology poses a number of challenges, Cunliffe asserted.
“Unlike existing payments systems which operate in central bank or commercial bank money, stablecoin payment systems issue their own money, the ‘coin’. This raises fundamental issues around the safety and interoperability of private money used in our economies,” Cunliffe warned.
The publication last week by CPMI-IOSCO of a report, for consultation, on how the international standards for systemic payment systems, the Principles for Financial Market Infrastructures (PFMI) should apply to stablecoin arrangements, was a major step towards ensuring the consistent application of international standards to crypto-based financial services, Cunliffe said.