Crypto Too Big to Fail: BoE Wants Regulation as “Matter of Urgency”

The deputy governor of the Bank of England, Sir Jon Cunliffe, has called for crypto regulation to be adopted as a “matter of urgency” as more institutions and retail investors look to buy cryptocurrency.

In a speech given on the 13 October, entitled Is ‘Crypto’ a Financial Stability Risk, Cunliffe in essence concludes: not yet but it will be very soon.

The deputy governor’s comments, thought to represent the thinking of the institution, come as the G20-created Financial Action Task Force (FATF) gets ready to publish its final crypto guidance by November.

FATF ”travel rules and VASP rules to have global implications

The international body, whose recommendations are invariably enacted by the G20 countries and in turn followed by the rest of the world, has already set out recommendations around the licensing of companies operating in the crypto sphere – what it defines as virtual asset service providers (VASPs). That’s in addition to previously agreed recommended requirements from the FATF that VASPs comply with anti-money laundering (AML) and combating-the-financing-of-terrorism (CFT) laws.

In November the exact shape of the rules in two controversial areas will be laid down. These are around the so-called ‘travel rules’ regarding the recording of the IDs of senders and receivers of crypto transactions and, secondly, the exact definition of what a virtual asset service provider is.

Both of those issues have already come to the fore in the US, when crypto regulation was introduced into the infrastructure bill being pushed by the Biden administration in the US.

Crypto becoming too big to fail

Regulators and central bank officials are becoming increasingly worried that crypto is on the verge of being too big to fail, leading to the possibility of its posing systemic risks for the financial system as institutions increasingly plan to enter the nascent asset class. The crypto universe of assets is now valued at $2.4 trillion, according to Coinmarketcap.

Cunliffe thinks there are “very good reasons” to think that crypto could be a risk in the near future if a digital asset were to see a speedy collapse in value.

A future cryptocurrency collapse could spread through markets, he warned.

In such circumstances investors who may have bought digital assets with borrowed money, perhaps from a broker, might be forced to liquidate other assets in order to meet cash demands.

Contagion fears a systemic risk to financial system

That could lead to wider contagion fears spreading through market. “A large fall in crypto valuations could affect investor risk sentiment more broadly, causing investors to sell other assets that are judged to be risky and those perceived to have a similar investor base,” said Cunliffe

He was particularly concerned about how the globalised nature of the financial system could lead to the rapid transmission of problems. “Interconnectedness creates the possibility that shocks are transmitted through the financial system,” he said.

Commenting on the speech by the BoE deputy governor, Susannah Streeter, senior investment and markets analyst at UK broker Hargreaves Lansdown, sees the intervention as yet another sign that regulators have reached a tipping point when it comes to crypto and have determined it is no longer tenable to ignore the sector.

‘’Regulators have been tip-toeing round the crypto world, shouting out occasional warnings to the crowds of speculators, but we now have the firmest indication yet that they will soon be stepping in to break up the block party.”

Hargreaves analyst: BoE Deputy Governor believes crypto “time-bomb is now ticking”

She continued: “The Deputy Governor of the Bank of England Sir Jon Cunliffe clearly believes the speculation has reached such a level that a crypto time-bomb is now ticking, which could blow up in the face of the financial sector.

“With unregulated crypto assets growing 200% this year alone from just under $800 billion to $2.3 trillion, and banks and hedge funds now becoming involved, the Bank of England is worried about contagion if the value of coins and tokens held deflates rapidly.”

Streeter also drew attention to how the UK’s Financial Conduct Authority has been growing increasingly concerned by developments in the crypto space, as consumers become more involved with influencers having outsized impact on what the FCA regards as ultimately highly speculative, and as such risky, investment decisions.

“The warning from the Bank of England comes hot on the heels of a call to action from the chair of the Financial Conduct Authority, Charles Randell in September. The FCA is extremely worried about the collision between social media and the crypto world, with Kim Kardashian’s single post about a token earlier this year considered to be the biggest financial promotion in history.

“Now, this nervousness about how financially vulnerable younger investors are being targeted by influencers has widened to an anxiety that the crypto wild west could undermine the stability of the financial system. There has been a hesitancy until now to bring crypto currencies into the regulatory sphere because of the risk it will add more legitimacy to the currencies.”

Regulators looking to separate speculative tokens from stablecoins

Interestingly, Streeter thinks regulators may be seeking to push “intense interest away from thousands of coins and tokens… towards stablecoins pegged to fiat currencies like the dollar”.

She cited a recent report from the central bankers’ banker, the Bank of International Settlements, which, as the analyst puts it, “set out how clearing and payments services should be applied to stablecoins”.

The press release for the consultation paper , which is drawn up under the auspices of the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO), prominently quotes Cunliffe.

Streeter highlights the possibility that the Basel Committee on Banking Supervision proposals for all crypto investments to set aside sufficient capital to cover 100% of possible future losses could be widely adopted. If they were it would make institutional involvement investing in cryptocurrency prohibitively expensive.

“Giving speculative tokens a high-risk price tag is likely to make crypto currency dealing and investment very expensive and could limit the number of new institutional entrants into the crypto world.
Regulators and central banks are walking a tricky tightrope, recognising the need to foster new decentralised payments technology but ensuring enough rules are in place to prevent runaway speculation infecting the wider financial sector.”

However, Streeter also notes the danger of over-burdensome regulation killing off innovation: “If the environment is made too cumbersome there is a risk that innovation in the fast moving world of decentralised finance could be quashed, slowing down the efficiency of operations and leaving the UK behind countries which are welcoming crypto with open arms.’’

Regarding the latest bitcoin rally, Streeter, in comments provided to Economy Watch, said: “Given crypto’s volatility the direction of travel for Bitcoin is far from certain. Price swings have become the norm and Bitcoin is just as likely to drop back down as it is to continue a climb upwards. However, its recent price spike is likely to concentrate minds further amongst central bankers and regulators as surges in crypto prices, often see more retail speculators entering the market hoping to catch a ride upwards. Regulators are worried about financially vulnerable consumers getting caught up out, if prices fall, especially as 14% are getting into debt to invest in crypto assets.”