Crypto assets could evolve to threatening financial stability due to their scale, structural vulnerabilities and increasing interconnectedness with the traditional financial system, warns a new report from the Financial Stability Board, an advisory group to the G20.
The dangers come from expanding linkages between crypto-asset markets and the regulated financial system; liquidity mismatch, credit and operational risks that make stablecoins susceptible to sudden and disruptive runs on their reserves, with the potential to spill over to short-term funding markets; the increased use of leverage in investment strategies; concentration risk of trading platforms; and the opacity and lack of regulatory oversight of the sector, according to the study.
The report cautions low levels of investor and consumer understanding of crypto-assets, money laundering, cyber-crime and ransomware are additional problems.
Last year, crypto asset capitalization grew nearly three and a half times but continue to remain a small part of overall global financial system assets.
With their small relative size, the report says price volatility in crypto assets has not spilled over to the traditional financial markets.
If the growth in scale and interconnectedness of crypt-assets at systemically important banks and other financial institutions were to continue, this could have implications for global financial stability, the FSB cautions. The growth has included activity at hedge funds which are putting more of their money into this asset class.
The study asserts that in the case of the US subprime mortgage crisis, a small amount of known exposure does not necessarily mean a small amount of risk, particularly if there exist a lack of transparency and insufficient regulatory coverage.
At the same time, the group says the rapidly growing retail investor adoption, and the use of leverage that any loss of confidence in crypto-assets could have implications that exceed those commensurate to the actual magnitude and direct financial interconnectedness of crypto-asset markets.
Stablecoins, the report says, pose a particular problem because of their structure which exposes them to liquidity mismatch, credit, and operational risks, making them susceptible to sudden and disruptive runs on their reserves.