The Bank of England (BoE) has called on policymakers to strengthen the global framework for regulating cryptos to prevent the assets from threatening the broader stability of financial markets.
Britain’s central bank Financial Policy Committee (FPC) said the role of prudential and market integrity regulators should be expanded and their coordination increased.
The $1.7tn (£1.3tn) crypto market is now larger than the $1.2tn market of sub-prime mortgages that triggered the global financial crash in 2008.
“Enhanced regulatory and law enforcement frameworks are needed, both domestically and at a global level,” the BoE committee said in minutes of its meetings on 9 March and 18 March, released on Thursday.
The FPC will conduct regular risk assessments, focussing on monitoring risks to systemic financial institutions and core financial markets, risks to the ability to make payments, and impact on real economy balance sheets.
It will make recommendations to the Treasury on adapting the remit for supervising crypto holdings, many of which are beyond the scope of the Financial Conduct Authority.
The watchdog does not currently regulate cryptocurrencies, however consumer protection and market integrity risks fall within the FCA remit. In January 2022 the FCA proposed tighter rules on how high risk financial products, including crypto assets are advertised.
FPC suggested that crypto tech carrying out an equivalent economic function to one performed in the traditional financial sector should come under the umbrella of existing regulatory plans.
Crypto assets, like bitcoin (BTC-USD) and ethereum (ETH-USD) are largely unregulated as they fall outside the legal scope. A change of law would be required to bring crypto under the full perimeter of UK securities rules, something the Treasury is already considering.
While the FPC acknowledged risks to the UK financial system from cryptocurrencies and DeFi are currently limited, but interest in the market is rising, bringing more risks in the future.
Assessing the relationship between cryptos and other asset classes such as gold (GC=F) or equities, the FPC said correlation remains “unstable” as highlighted by the relative price movements of cryptos since the start of the Ukraine war.
“As cryptoassets started to be more integrated in investors’ portfolios, market movements had generally become increasingly correlated with conventional risky assets, such as equities,” the FPC said.
Bitcoin enthusiasts have long touted it as a safe haven to hedge against inflation and other risks in traditional markets, often comparing it to gold.
So far gold has outshined the so-called “digital gold” as a safe haven as western nations ramp up punitive sanctions on Moscow to isolate it from the global financial system.
The central bank wants to ensure that risks from crypto assets are controlled in Britain’s banking sector until cryptos are fully regulated under one net.
Deputy governor Sam Woods has warned banks that the long-term regulation of crypto assets is likely to differ from the current framework.
Assessing the City’s exposure to crypto assets, the BoE has asked companies to disclose information on their plans in cryptocurrencies.
In a letter to CEOs on Thursday, Woods gave firms a 3 June deadline by which financial services firms are expected to voluntarily inform the BoE of their current and planned exposures to crypto during this year.
Noting that businesses have taken limited exposure to cryptos, he said the BoE is “aware of increased interest from banks and designated investment firms … in entering various crypto markets”.
“This letter is intended to ensure that where firms do have exposures, they understand our expectations around risk management and measurement against the existing prudential framework,” said Woods.
“They [crypto assets] have limited history, different risk profiles, can be characterised by very high volatility, and have market participants and structures that can be significantly different from the other markets in which firms participate.”
The BoE and the FCA will carry out further work on rules for stablecoins and consult on a regulatory “model” for systemic stablecoins in 2023, the FPC said.
It added that stablecoins, which are backed by assets or cash, that became systemically important would need to be backed by high-quality, liquid assets and loss-absorbing capital similar to that held by banks.
Warning that using deposits with commercial banks to provide backing for stablecoins would pose significant financial stability risks if pursued at scale.
Stablecoins are a class of cryptocurrencies that attempt to peg their market value to some external reference such as the US dollar or a commodity’s price like gold to offer price stability.
Cryptos have recently come under the regulatory spotlight amid concerns they could be used to circumvent economic sanctions imposed on Russia since its invasion of Ukraine.
Earlier in March, the Joe Biden administration signed a long-awaited executive order on cryptocurrency regulation, instructing agencies to officially recognise and regulate digital assets in the US.
Meanwhile, European Union parliamentarians voted against a new provision in a crypto regulatory framework, which could have seen key digital currencies like bitcoin and ether banned in Europe.