Crypto threatens financial stability says BoE banker

Jon Cunliffe, the Bank of England’s deputy governor for financial stability has recently given a speech where he tackled the question of whether or not, “the world of ‘crypto finance’ poses risks to financial stability.” Why and how does it do that?

Cunliffe pointed out that cryptoassets have grown by roughly 200% in 2021 ($2.3 tn), and from $16 billion just five years ago. The global financial system is worth $250 trillion, to give some context. He also mentioned that the sub-prime debt market was worth around $1.2 trillion in 2008, just before the financial crisis.

His point in using this comparison was that because the crypto industry is growing rapidly and beginning to connect to the traditional financial system, and there are leveraged players emerging in a mostly unregulated space, systemic risks, while limited now, could grow very quickly.

Referring back to 2008, he reminded his audience that in the case of the sub-prime market, “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.” We all remember the effects.

He called for financial stability regulators to take notice, to think very carefully about what could happen and whether they, or other regulatory authorities, needed to act. However, he cautioned against over-reaction. As he said, “We should not classify new approaches as ‘dangerous’ simply because they are different.”

Indeed, he said that innovation and technology, plus new players, could tackle longstanding frictions and inefficiencies and reduce barriers to entry, and that in the past they have been key to driving improvement and to increasing resilience in financial services.

Then, what started as a speech that may have sounded gloomy to the crypto markets, Cunliffe made an important and positive statement. He said, “Crypto technologies offer a prospect of radical improvements in financial services.” But he did add a caveat, “However, while the financial stability risks are still limited, their current applications are now a financial stability concern for a number of reasons.”

He then analysed the crypto market, breaking it down into unbacked cryptoassets used primarily as speculative investments and backed cryptoassets intended for use as a means of payment, pointing out that unbacked assets make up 95% of the market, and includes Bitcoin. His concern is that the main use of unbacked cryptoassets is for speculative investment and that fewer holders now say they see them as a gamble and more see them as an alternative or complement to mainstream investment. His greatest fear appears to be that while he doesn’t believe a collapse in the crypto retail investor sector would bring about instability, the large financial institutions with exposure to crypto are another matter, such as the many crypto hedge funds. He described one scenario: “For example, a severe fall in the value of cryptoassets could trigger margin calls on crypto positions forcing leveraged investors to find cash to meet them, leading to the sale of other assets and generating spillovers to other markets.”

Ultimately, Cunliffe called for faster action on regulating the market to manage risk, saying, “Although crypto finance operates in novel ways, well-designed standards and regulation could and should enable risks to be managed in the crypto world as they are managed in the world of traditional finance.”

While he sounds positive, as ever the demand is to bring crypto more in line with traditional finance, the very thing that caused the creation of crypto in the first place, due to ‘tradition’s’ failings.

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