Bank of England outlines risks and regulation of crypto assets
The Bank of England, the central bank of the United Kingdom, in its March issue of the Financial Stability in Focus report set out the views of the Financial Policy Committee (FPC) on crypto assets and decentralized finance. FPC believes that improved regulatory and enforcement frameworks, both nationally and globally, would be needed to encourage sustainable innovation as well as to maintain broader trust and integrity in the financial system.
The paper dwells extensively on the role of crypto assets and decentralized finance in the financial system, implications for financial stability, FPC’s approach to monitoring risks, including related financial stability risks , as well as the status of regulatory initiatives.
The FPC report acknowledges that the Technology underlying crypto assets have the potential to reshape activity in the traditional financial sector and lead to several benefits, including lowering costs, improving the speed of cross-border payments by enabling peer-to-peer transactions, reducing the need for centralized intermediaries, increasing competition and further reducing costs for end users. Distributed ledger technology could potentially be used to make financial market infrastructure (FMI) processes (especially settlement) more efficient, transparent and resilient, he says.
As a crystallization of vulnerabilities in crypto assets and the DeFi space could affect financial stability, FPC believes it is essential to mitigate financial stability risks to ensure lasting benefits from new technologies.
The FPC recognizes that potential risks related to crypto assets and DeFi could be operational risks arising from the use of crypto technology, regulatory and stability challenges or financial risks due to direct exposures or spillovers between markets. These could result from interconnections between crypto assets and the traditional financial sector, as well as the growth of activity outside the existing regulatory perimeter.
Risks to systemic financial institutions such as banks and insurers, risks to major financial markets, risks to ability to make payments and impact on reality economy balance sheets are seen as the main channels through which risks to financial stability could arise.
The report indicates that the growth of stablecoins for payments could increase the role of non-banks in the financial system and that opportunities for regulatory arbitrage could arise. The composition of assets backed by stablecoins may, in some cases, not be sufficient to cope with massive redemptions, which could create risks for the entire financial system. A fire sale of stablecoin backing assets could disrupt the functioning of some markets if they were to expand significantly, according to the report.
Public confidence in currency and payments could be undermined if a systemic stablecoin used for payments fails to meet its obligations. In this context, the FPC had previously defined the expectations that systemic stablecoins should meet before widespread adoption as a means of payment.
The CPF is also concerned that the increase in institutional investments will have repercussions on the main financial markets. He also believes that where the traditional financial sector and the crypto sector perform an equivalent economic function, this should be done within existing regulatory arrangements. The Committee is of the opinion that in such cases, the regulatory perimeter should be adapted in order to ensure an equivalent regulatory result.
The committee, whose primary responsibility is to contribute to the financial stability objectives of the Bank of England, believes that direct risks to the stability of the UK financial system from crypto assets and DeFi are currently limited.
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