• Cryptocurrencies are not an uncorrelated asset class
• Strengthen the system’s resilience
• Basic measures to protect investors
“It is important that the foundations for sound regulation of the crypto-financial system are laid now, before the crypto-ecosystem becomes so large and interconnected that it could pose a risk to the stability of the broader financial system,” said Fed Vice President Lael Brainard. at the Bank of England conference in London.
Regulatory framework despite crypto winter
Lael Brainard pointed to the crypto market’s lack of a regulatory framework given the recent volatility in cryptocurrency. The mood in the crypto market has significantly worsened after the Terra/LUNA debacle and the price collapse of Bitcoin, Ethereum & Co.
Crypto platforms are just as vulnerable to deleveraging, fire sales or contagion risk as traditional ones financial markets. This is reflected in the fact that both small investors and large players have suffered huge losses and are now trying to liquidate their holdings.
The interconnectedness within the crypto universe became evident when the financial difficulties of multi-billion dollar hedge fund Three Arrows ultimately led to the insolvency of crypto exchange Voyager Digital. According to Brainard, the recent turbulence in the crypto market has shown that cryptocurrencies are neither a hedge against inflation nor an uncorrelated asset class. The collapse of the Terra stablecoin is a reminder of how quickly a supposedly stable asset can lose its tie to a fiat currency and proves that new technologies alone cannot provide security for risky assets.
Security and growth through regulation
The digital ecosystem can use its innovations to make financial services faster, cheaper and more inclusive. However, the industry needs some degree of regulatory certainty to develop and expand projects. Crypto investors also lacked government measures to secure their investments.
A systemic risk to the global financial system does not exist, the vice chairman of the US central bank said, because the crypto industry has not yet reached the appropriate size and coherence. Therefore, now is the right time to “determine which crypto activities are permitted for regulated companies and under which restrictions, so that knock-on effects on the core financial system remain well contained”.
National and international cooperation on crypto regulation is now needed, especially in DeFi (decentralized finance) and platforms, to improve the future resilience of the crypto industry. Basic protection measures for consumers and investors must be taken under the premise of “same risk – same regulation – same result”.
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“We found that crypto-trading platforms and crypto-lending institutions not only engage in activities similar to those in traditional finance without complying with comparable regulations, but also combine activities that should be separated in traditional financial markets,” Brainard said in his speech. Because on some platforms market infrastructure and customer care are mixed with risky transactions. As a result, investors had to be protected and crypto-platforms had to be subject to comprehensive, generally applicable rules, for example in relation to anti-money laundering, terrorist financing or financial sanctions support.
Earlier this year, President Joe Biden announced that he would introduce regulatory measures for the crypto industry. The US president signed an executive order to this effect in March, but without being too specific.