The European Securities and Markets Authority (ESMA) in a recent report “Crypto Assets and their Risks to Financial Stability” warns investors about the potential dangers of a merger of crypto and traditional financial markets.
Due to their volatile growth cycles and as long as there are no relevant regulations in place, crypto-assets pose several risks that may become relevant to financial stability in the future
The growing overlap between the two markets requires increased monitoring and regulatory oversight, it said. In addition to market volatility and the risk of leveraged positions, the report provides a recommendation for action.
For starters, the agency notes that the crypto market would “become increasingly similar to traditional financial markets and infrastructure.” The growing awareness among crypto investors has been clouded by worsening macroeconomic conditions. “Rising inflation and the end of the low interest rate era have eroded previously optimistic investor sentiment and caused a dramatic sell-off in the crypto-asset market,” the report said.
The report also refers to the hype phase in 2021, which brought many investors into the market. ESMA is also dealing with current developments in the crypto market and addressing the collapse of the Terra stablecoin, which the market regulator sees as ultimately responsible for the crypto market crash.
Fear of adoption and trading with leverage
“There are multiple transmission channels between the crypto market and the traditional financial system,” it continues. In this connection, the supervisory authority consults an investigation from April. The result of the investigation at the time: 90 European investment funds are involved in direct investments in the crypto sector. Twenty others wanted to earn indirectly via derivatives.
ESMA appears to be concerned about the increasing interdependence between the classical financial market and the crypto market. Best example: Tesla. In 2021, it was first said that the Californian company’s cars could be purchased using Bitcoin. The e-car manufacturer then backed away from the decision. In both communications, Musk significantly influenced the Bitcoin price.
By the way: In the new BTC-ECHO Magazine you can read the whole story behind the ambivalent relationship between Tesla and Bitcoin.
In addition, ESMA officials are concerned about “investment opportunities that are too risky”. Exchanges such as Huobi or Bybit now allow their investors to trade cryptocurrencies with a leverage of up to 125 times – this quickly leads to a total loss.
ESMA sees a need for action on regulation
With the MiCA regulation, the EU is the first major jurisdiction in the world to provide a comprehensive, dedicated regulatory framework for cryptoassets. This will give ESMA new powers to decide exactly what to include in the white papers for newly issued assets.
Attempts are also being made outside of Europe to limit crypto-related financial market risks. The Howey test is intended to be used in the United States to determine whether cryptocurrencies are regulated as commodities or securities. There is a heated debate as to what area of responsibility cryptoassets fall under. Most recently, the SEC claimed that Ethereum blockchain transactions would be entirely under US jurisdiction. BTC-ECHO reported.
ESMA wants regulatory help from other authorities, such as the Financial Stability Board (FSB): “The cross-border nature of the crypto-asset market should not be underestimated.”
Crypto market of limited relevance
According to the report, even at its peak, the crypto market was worth just 1 percent of the combined market value of stock and bond assets. This is an indicator of “limited relevance to financial stability.” Nor would the turmoil in the market for crypto assets spill over into traditional financial markets or the real economy.
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