The crypto industry’s deepening ties with banks and asset managers will pose a risk to financial stability, the European Central Bank has warned, in the latest sign of how central banks and governments intensify their market surveillance.
The ECB said on Tuesday that it had taken “a deep dive into crypto-asset leverage and crypto lending” and found evidence that these activities were becoming more risky, complex and interconnected with traditional institutions.
“Investors have been able to manage the €1.3 billion drop in unsecured crypto-asset market capitalization since November 2021 without any risk to financial stability,” the ECB said. . “However, at this rate, a point will be reached where unsecured crypto-assets will pose a risk to financial stability.”
The ECB’s first such warning, issued as part of its biannual Financial Stability Review, followed similar messages from US and UK authorities, who have been troubled by a series of recent market failures in cryptography.
Bitcoin, the world’s flagship cryptocurrency, has halved in value since November and recently fell below $30,000 for the first time since last summer. The market’s most important stablecoin, tether, momentarily lost its peg to the US dollar, while rival terraUSD all but collapsed.
US Treasury Secretary Janet Yellen recently warned that stablecoins present the same kind of risks associated with bank runs, echoing a similar comparison from the Federal Reserve.
ECB President Christine Lagarde said this weekend on Dutch television that a crypto token is worth “nothing, it is not based on anything, there is no underlying asset to act as an anchor of security”. Fabio Panetta, an ECB executive, recently likened the sector to a “Ponzi scheme” and called for a regulatory crackdown to avoid a “lawless risk-taking spree”.
The central bank is working on a digital euro and aims to build a prototype to test by next year before deciding to launch it three years later. Lagarde said his own central bank-backed digital currency would be “very different from a lot of these things.”
Ties between eurozone banks and crypto assets “have been limited so far,” the ECB said in its report on Tuesday, adding: “Market contacts indicate there was growing interest in 2021, primarily through expanded wallets or ancillary services associated with digital assets (including custodial and trading services)”.
He said that major payment networks have “increased their support for crypto-asset services” and that institutional investors are “now also investing in bitcoin and crypto-assets more generally.”
Noting that German institutional investment funds have been allowed to invest up to a fifth of their holdings in crypto assets since last year, he said such investments have been facilitated by the availability of crypto derivatives and securities. listed on the stock exchange.
The ECB also cited the risks of decentralized finance, or DeFi, in which cryptocurrency-based software offers financial services without the use of intermediaries such as banks.
“Crypto credit on DeFi platforms grew 14x in 2021, while total value locked hovered around €70 billion until very recently, on par with smaller domestic peripheral European banks,” he said. -he declares. Remortgage, in which the security of one loan can be pledged against another loan, has increased the risk of exceeding debt limits.
Some crypto exchanges offer loans to customers to allow them to increase their exposures up to 125 times their initial investment, the ECB said. But “significant information and data gaps persist,” meaning “the extent of possible contagion channels with the traditional financial system cannot be fully determined.”
According to a recent ECB survey, as many as one in 10 households in the EU “may own crypto-assets”, although most have invested less than €5,000 in the sector. Similarly, a Fed survey released on Monday found that 12% of American adults held or used cryptocurrencies in 2021.
The EU is finalizing legislation, called Crypto Asset Markets, but the ECB has said it won’t come into force until 2024 at the earliest. “Given the rapid pace of crypto developments and growing risks, it is important to bring crypto-assets into the regulatory perimeter and under scrutiny as a matter of urgency,” he said.
Additional reporting by Scott Chipolina in London