Fast-evolving crypto markets could be a threat to global financial stability, according to the Financial Stability Board (FSB), an international organization that monitors and makes recommendations for the global financial system.
In a report published Wednesday, the FSB examined potential vulnerabilities connected to unbacked crypto assets like bitcoin, stablecoins (cryptocurrencies tethered to the value of real assets) and decentralized finance (DeFi) along with crypto trading platforms.
Funded by the Bank for International Settlements, the umbrella group for central banks, the FSB is chaired by De Nederlandsche Bank President Klaas Knot.
Although the global crypto market is still relatively small and the extent of crypto use around the world varies, risks to financial stability “could rapidly escalate,” the FSB said. It emphasized the need for proactive evaluation of policy responses.
The new report comes after regulators in multiple jurisdictions including in the U.S. and U.K. reached similar conclusions. In the five years through October 2021, the cryptocurrency market capitalization grew around 200% to a record $2.7 trillion. It is currently about $2 trillion, according to CoinMarketCap.
“Crypto-asset markets are fast evolving and could reach a point where they represent a threat to global financial stability due to their scale, structural vulnerabilities and increasing interconnectedness with the traditional financial system,” the report said.
Pace vs. scale
Despite the multitrillion-dollar market cap, crypto still makes up a small portion of the assets within the global financial system, according to the FSB. While connections between the crypto market and traditional financial markets are growing fast, they remain limited, the report said.
More traditional participants in global finance began paying attention to crypto during the 2021 price run, but investment has been slow to pick up. While corporations including MicroStrategy and Tesla have significant bitcoin exposure, firms such as Morgan Stanley and JPMorgan seem more cautious.
“Nevertheless, institutional involvement in crypto-asset markets, both as investors and service providers, has grown over the last year, albeit from a low base,” the report 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."
In October the FSB said the $133 billion global stablecoin market was still too small to be considered as a mainstream payment method. The new report suggests the rapid growth of DeFi and the stablecoins that power the sector could harm financial markets if something were to go wrong.
“Were a major stablecoin to fail, it is possible that liquidity within the broader crypto-asset ecosystem (including in DeFi) could become constrained, disrupting trading and potentially causing stress in those markets. This could also spill over to short-term funding markets if stablecoin reserve holdings were liquidated in a disorderly fashion.”
The report did not provide any recommendations other than stating the need to preemptively consider policy options for regulating the sector. It did say that it will continue to monitor and recommend effective ways to implement its guidance on global stablecoins from 2020.
CORRECTION (Feb. 16, 10:23): Clarifies the FSB is chaired by De Nederlandsche Bank President Klaas Knot.