On 13 October 2021, Sir John Cunliffe, Deputy Governor for Financial Stability at the Bank of England, gave a speech discussing the financial stability risk posed by crypto.
Crypto is the underlying technology – the application of cryptographic innovation to the recording and to the transfer of the ownership of assets, often on public networks open to all. Unbacked crypto-assets (i.e. Bitcoin) make up 95% of crypto assets and are used primarily as speculative investments, the price volatility of these assets makes them unsuitable for use as a settlement asset for payment. Whereas, backed crypto-assets (stablecoins) are intended for use as a means of payment within crypto markets, though they are beginning to be used by wholesale financial players and large corporates.
These assets have begun to connect the financial system and Sir John talks about how regulators should be responding to their rapid growth.
The speech includes the following comments:
- Crypto assets have grown by roughly 200% in 2021, from just under $800 billion to $2.3 trillion today.
- Crypto technologies offer the prospect of radical improvements in financial services. However, their current applications are a financial stability concern because:
- They currently operate in an unregulated space.
- The bulk of crypto assets are highly volatile as they have no intrinsic value and are vulnerable to major price corrections, due to the fact they have no assets or commodities behind them, their value is determined solely by the price the buyer is willing to pay at any given moment.
- Well-designed standards and regulation should enable financial risks to be managed in the same way they are managed in traditional finance. Bringing the crypto world within the regulatory perimeter will allow their benefits to flourish in a sustainable way.
Sir John also touched briefly on decentralised finance which demonstrates the increasing complexity and potentially growing risk in the crypto ecosystem. It is decentralised and algorithm-based, relying on smart contracts and is delivered without intermediaries. Most commonly used as a provision of credit. The decentralised global structure and difficulty to trace end users poses a unique set of challenges for regulators.
In his conclusion Sir John said:
“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. As the chairman of the SEC has observed, “financial innovations throughout history do not flourish outside public policy frameworks”.
Developing the standards and regulation that effect those public policy frameworks is, and should be, a painstaking, careful process. But one cannot help observing that in the two years it has taken to develop the draft CPMI-IOSCO guidance, stablecoins have grown sixteen-fold, although admittedly only to a relatively small amount.”