But stablecoins could be susceptible “to sudden and disruptive runs on their reserves” which could create “knock-on effects to short-term funding markets” in the traditional finance system, especially if stablecoin reserves were liquidated in a disorderly fashion, the FSB said. Problems will be exacerbated if “global stablecoins” are developed.
The latest FSB paper come as Australian regulators work with Treasury to develop a regulatory model for crypto that provides investor protections, while also recognising the crypto industry could contribute material jobs to Australia. A report by a Senate select committee last year said a thorough regulatory regime could help create legal certainty for blockchain developers and attract them to work in Australia.
Blockchain technology allows financial services to be delivered without regulated banks or brokers acting as intermediaries, as transactions are monitored by decentralised computer networks using cryptography to secure records of ownership.
The Basel, Switzerland-based FSB warned about growing linkages between crypto-asset markets and the regulated financial system. It is concerned about the increased use of leverage in investment strategies and the concentration risk of trading platforms.
“Financial stability risks could rapidly escalate, underscoring the need for timely and pre-emptive evaluation of possible policy responses,” the FSB said.
With the amount of funding locked into DeFi protocols around $US100 billion in December, up four times over last year, the FSB said it’s challenging for regulators “to identify an entity or individual accountable for meeting regulatory obligations”. It is concerned about the lack of “know your client” (KYC) checks across the sector, given the verification of identify is not required.
DeFi related hacks made up over 75 per cent of the $US481 million (about $700 million) known theft volume of crypto-assets to September 2021 and the FSB said if the sector continues to increase in size, “the crystallisation of these vulnerabilities might have consequences for the functioning of, and confidence in, the broader financial system”.
The board is also worried about retail investors and the potential for negative wealth effects in a severe market downturn. “Widespread holdings of crypto-assets by retail investors with limited knowledge of the market functioning including transaction fees, and given the lack of investor protections, or recovery and resolution frameworks, could result in adverse confidence effects.“
Connections between crypto and existing banks are limited but expected to deepen, the FSB said. “If the current trajectory of growth in scale and interconnectedness of crypto-assets to these institutions were to continue, this could have implications for global financial stability.”
Commonwealth Bank became one of world’s first major banks to say it would add crypto to its banking app, in partnership with US exchange Gemini. Gemini, in which CBA holds a small equity stake, has a similar offering to BlockFi, known as Earn.
Despite Coinbase shares trading down almost 40 per cent since its April 2021 IPO, regulators expect more crypto players to hit public markets. Circle, which issues the USDC stablecoin and has partnered with Visa, is seeking to become a US national bank charter and intends to go public.
Regulators are also monitoring crypto in payments. This is limited at present due to high transaction fees and price volatility. But some mainstream payment service providers including PayPal have announced steps to support crypto-assets, and the FSB said use for payments could increase if transaction fees fall or stablecoins migrate to low or zero fee blockchains.
The SEC action against BlockFi, which has raised $US3 billion in venture funding from investors including Bain Capital Ventures and Tiger Global, has drawn attention to whether national securities laws are fit-for-purpose to regulate new crypto business models.
BlockFi pays yields to those providing crypto, including USDC or bitcoin, which is lent out. The SEC found this week BlockFi is dealing in securities and had operated illegally for 18 months as an investment company. But SEC commissioner Hester Peirce criticised the ruling, saying “we need to commit to working with these companies to craft sensible, timely, and achievable regulatory paths”.
Treasury is developing powers to control cryptocurrency exchanges under a new category of Australian financial markets licence, creating protections for bitcoin investors including local custody rules. Australia is also planning a new company structure to support ‘decentralised finance’ players.
