Digital currencies could trigger financial meltdown

Regulators need to work quickly to implement a set of rules for crypto currencies,  because of the “plausible” risk of a collapse in the market, said Bank of England Deputy Governor Jon Cunliffe in a speech to the SIBOS conference.

He added, “You don’t have to account for a large proportion of the financial sector to trigger financial stability problems,. 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.”

He added, a collapse could happen “given the lack of intrinsic value and consequent price volatility, the probability of contagion between crypto assets, the cyber and operational vulnerabilities, and of course, the power of herd behaviour.”

Crypto assets are currently worth $2.3 trn, about 200% more than at the start of the year. While they still account for a small part of the $250 trn global financial system, it’s about twice the size of the $1.2 trn sub-prime real estate debt market in 2008.

In the past regulators have dismissed digital currencies as assets without an intrinsic value that may go to zero. Although Cunliffe repeated that refrain, he also noted ways that the technology is providing a genuine service that are appealing to more investors and financial institutions.

He pointed out that major banks are offering digital currency custody services and offering the assets to some wealth-management clients

Moreover, at least 150 to 200 specialist crypto hedge funds are handing the assets, and traditional funds are growing more interested

The result, according to Cunliffe is that crypto assets are being integrated into the financial system.

“Recording and transferring ownership of assets is the bedrock of the financial system’s role in storing value and in making transactions,” Cunliffe said. “Crypto technology enables — though it does not require — recording and transfer to take place without the banks or custodians that have historically carried out this function.”

Last week, global regulators proposed that the safeguards they apply to systemic clearing houses and payment systems should also be applied to stable coins, a type of cryptocurrency typically backed by an asset or fiat currency, but they only make up 5% of crypto assets. read more

Cunliffe, who helped to lead the work, said it took two years to draft this measure, during which stable coins have grown 16-fold.

“Indeed, 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 way,” he added.

©Markets Media Europe 2021

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