The risk of financial stability due to crypto assets is increasing, and the ecosystem of crypto assets is becoming more complex and interrelated. This issue of Macroprudential Bulletin delves into the risks and policy implications of several segments of the crypto asset market. One of the central elements is stablecoin. With Stablecoin’s growth, innovation and growing global use cases, there is an urgent need to implement appropriate regulatory, oversight and surveillance frameworks before significant interconnection with traditional financial systems occurs. .. Another fast-growing segment within the crypto ecosystem is decentralized finance (DeFi). This is a new way of providing financial services independent of centralized intermediaries, with specific financial stability risks and regulatory challenges. Finally, this issue highlights the risk of climate change in the financial sector due to the significant carbon footprint of certain crypto assets such as Bitcoin and proposes potential measures that authorities can take.
Cryptocurrency assets have existed for over a decade without playing a significant role in the financial system, but are growing. In 2008, a group of software developers or developers using the pseudonym Satoshi Nakamoto developed the source code to create Bitcoin, aiming to be the first decentralized digital currency.[1] Since then, numerous crypto assets and the complex and growing ecosystem around them have emerged, spanning subsegments from Stablecoin to DeFi and non-fungible tokens (NFTs). Explosive growth since the end of 2020 and increased interrelationships with other parts of the financial system have led to ongoing discussions on global policies on the relevance and risk of crypto assets in the financial system.
The risk of financial stability due to crypto assets is increasing and can reach systematic thresholds. Recent analysis by the Financial Stability Board (FSB) and the ECB suggests that the nature and size of the crypto asset market is evolving rapidly. If the current trend continues, crypto assets pose a risk to financial stability. Therefore, the crypto asset market needs to be effectively regulated and supervised.[2] The turmoil in markets where crypto assets are used can have a spillover effect on regulated financial markets in the absence of timely regulatory intervention. The cross-border global nature of the ever-growing world of crypto assets requires a holistic and coordinated approach between authorities.
This issue of Macroprudential Bulletin delves into the risks and policy implications of several segments of the crypto asset ecosystem. Major unsubstantiated crypto assets such as Bitcoin and Ether continue to be the most popular assets in the crypto world, but over the last two years, more types of crypto assets have emerged and have expanded significantly. (Figure 1). This adds complexity and new features within the crypto asset ecosystem. For example, Stablecoin has created further reciprocal links by acting as collateral for derivative transactions of crypto assets or as a liquidity provider for DeFi. At the same time, the growing interest of organizations has expanded the interrelationship between the crypto asset ecosystem and the traditional financial system.
Chart 1
Market Capitalization-Indexed Growth of Selected Segments of the Cryptocurrency Ecosystem
(January 1, 2021 = 1)
Source: CryptoCompare and ECB calculations.
Note: Cryptocurrency assets based on the Proof of Work consensus mechanism: Bitcoin, Ether. Cryptocurrency assets based on the Proof of Stake consensus mechanism: Cardano, Solana.
Given the central role of Stablecoin in the crypto asset ecosystem, Adachi et al. (2022) Analyze their role in the crypto asset market and its possible impact on financial stability. Stablecoin relies on tools to maintain a stable value for one or more currencies or other assets (including crypto assets), or uses algorithms to maintain a stable value. It is a unit of digital value (so-called algorithm stablecoin).[3] These were developed to deal with high price fluctuations in unsubstantiated crypto assets such as Bitcoin and Ether, and due to their relatively low volatility, stablecoin with many features that this property requires. Is destined. However, at the early May event, where the algorithm’s stablecoin TerraUSD crashed and the largest stablecoin (Tether) temporarily lost its pegs, stablecoin may not be as stable after all. It shows that. Against the backdrop of last year’s rapid growth of Stablecoin and its increasing global use cases and potential financial risk transmission channels, this article discusses Stablecoin within and beyond the broader crypto ecosystem. Focus on the role it plays.
An important feature that some stable coins will help in the broader crypto asset ecosystem, and for unsupported crypto assets, is if unsupported crypto assets pose a risk to financial stability at some point in the future. It can have a contagious effect on the financial system. Given that the largest stablecoin plays an important role in the liquidity of the crypto market, if one of the largest stablecoins runs or fails, this can have a wide range of impacts on the crypto market. there is. Similarly, if there is a risk to financial stability at some point in the future crypto asset market, this can have a spillover effect on the financial system. Execution in Stablecoin can also have a spillover effect on the financial system, usually through the large-scale redemption of reserve assets, which usually consist of traditional assets such as government bonds and commercial paper. Developments related to the crash of the algorithm Stablecoin TerraUSD exemplify transmission within the crypto asset ecosystem. In the stress of the crypto asset market that followed, tether prices were under pressure and the largest stablecoin temporarily lost its pegs. Tether faced a major outflow of more than 10% of its market capitalization and had to redeem it by liquidating its reserve assets. On the other hand, other major collateralized stablecoins showed a slight inflow.
Stablecoin is less than what is needed for a real payment instrument in the real economy. To date, stablecoin transaction speeds and costs, and their redemption terms, have proven to be inadequate for use in real economy payments... In addition, European payment service providers have not been very active in the stablecoin market so far, and their activities vary considerably between EU member states.
Appropriate regulatory, supervision and monitoring frameworks need to be urgently implemented in advance Stablecoin poses a risk to financial stability. The financial stability risk of stablecoin in the euro area is still limited. However, this may change in the future if growth trends continue at the current pace. Existing Stablecoin needs to be urgently brought to the boundaries of regulation. In the EU, the European Commission’s proposed Cryptocurrency Market (MiCA) regulation marks an important milestone. This is a custom-made system for issuing and providing services related to Stablecoin and other crypto assets, for example, only e-commerce and credit institutions issue stablecoin and crypto asset service providers. You can set approval and health requirements. It should be implemented as an urgent matter.
Another segment of the world of crypto assets that expanded rapidly last year is DeFi, which was featured by Born et al. (2022) This Macroprudential Bulletin focus piece. DeFi represents a new way to provide financial services. Eliminate traditional centralized intermediaries and rely on automated protocols instead. For the most part, it does not create innovative financial products, but it mimics the products offered in traditional financial markets through technology-driven innovation. However, certain features such as how to retain assets, how to generate trust, and how to manage the system are different from traditional finance. DeFi is vulnerable to many of the same vulnerabilities as traditional finance, including excessive leverage and risk taking, liquidity mismatches, and vulnerabilities caused by interconnects. However, its new technology and delivery methods may amplify certain vulnerabilities and pose additional specific risks. The crash of Stablecoin TerraUSD in early May indicates some of these vulnerabilities. This is because the DeFi size (“total value locked”) measured by the sum of all digital assets deposited under the DeFi protocol dropped significantly in early May.
DeFi needs to be effectively monitored and regulated. The basic principles of “same business, same risk, same rules” should be applied to DeFi. The lack of traditional centralized entry points for regulation and its opaque and anonymous nature pose challenges for policy makers in terms of enforcement and effective regulation and supervision. As vulnerabilities begin to grow, an internationally coordinated approach is needed to mitigate the risks of DeFi. This requires careful analysis to close the actual regulatory gap from the lack of enforcement. If regulatory gaps are identified, entry points related to regulations and regulatory standards are required.
Gschossmannetal. (2022) Address climate transition risk in the light of significant carbon dioxide emissions of certain crypto assets. The functioning of certain crypto assets (such as Bitcoin) uses disproportionate amounts of energy that conflict with public and private environmental policies and objectives of the environment, society and governance (ESG). There is likely to be government intervention. Markets and investors may not price correctly with such interventions. As a result, climate change risk is expected to increase as the financial sector’s exposure to crypto assets increases.
Governments are primarily responsible for policy, but financial institutions and soundness standard setters also have a role to play. Public authorities need to assess whether the oversized carbon dioxide emissions of certain crypto assets undermine green transition efforts. Investors need to assess whether their investment in a particular crypto asset is in line with ESG objectives. Financial institutions need to incorporate the climate-related financial risks of crypto assets into their climate strategies. For soundness standard setters, there are several regulatory options for defining capital requirements. These range from risk-sensitive approaches in the form of risk-weighted add-ons to capital deduction approaches to all new exposures to crypto assets with a significant carbon footprint.
References
Adachi, M., Bento Pereira Da Silva, P., Born, A., Cappuccio, M., Czák-Ludwig, S. , Gschossmann, I., Paula, G., Pelicani, A., Philipps, SM. , Plooij, M., Rossteuscher, I. and Zeoli, P. (2022), “The role of stablecoin in cryptocurrencies and beyond: features, risks, and policies“, Macro Prudential BulletinNo. 18, ECB, July.
Born, A., Gschossmann, I., Hodbod, A., Lambert, C. and Pellicani, A. (2022), “Decentralized Finance-A New Unregulated Non-Banking System?“, Macro Prudential BulletinNo. 18, ECB, July.
Bullmann, D., Klemm, J. and Pinna, A. (2019), “Seeking Stability of Cryptocurrencies: Is stablecoins the solution?“, Extraordinary paper seriesNo 230, ECB, August.
ECB Crypto-Assets Task Force (2020), “Stablecoins: Monetary Policy, Financial Stability, Market Infrastructure and Payments, and Impact on Eurozone Banking Supervision“, Extraordinary paper seriesNo 247, ECB, September.
Financial Stability Board (2022), Risk assessment of financial stability from crypto assets, February.
Gschossmann, I., van der Kraaij, A., Benoit, PL. And Rocher, E. (2022), “Environmental Mining – Are Climate Risks Priced on Cryptocurrency?“, Macro Prudential BulletinNo. 18, ECB, July.
Hermans, L., Ianiro, A., Kochanska, U., Törmälehto, VM. , Van der Kraaij, A. and Vendrell Simón, JM (2022), “Decoding financial stability risk in the crypto asset marketSpecial Feature A, Financial stability reviewECB, May.
Satoshi Nakamoto (2008), Peer-to-peer electronic cash system, www.bitcoin.org.
