The deputy governor of the British central bank explains why the rapid rise of cryptocurrencies worries him – and why governments cannot avoid preparing for a crypto market crash.
It’s not there yet. Sir Jon Cunliffe, deputy governor of the Bank of England, said in an interview with BBC Radio 4: “As I assess the situation, bitcoin and other crypto assets and their value are not a threat to financial stability at the moment. “
Jon Cunliffe, deputy governor of the Bank of England, warned that cryptocurrency assets such as Bitcoin were increasingly posing risks to financial stability, arguing that regulators and legislatures needed to be careful about the risks ahead. risk cryptocurrency bigomex pic.twitter.com/tGuWO1woaj
– BigoMex (@BigoMexofficial) November 17, 2021
The emphasis is on “for the time being”. There is no reason to breathe a sigh of relief. Neither for the crypto scene, which is not very keen on this kind of attention, nor for the central bankers, from whom Bitcoin and Co. are taking the butter off the bread. Because, Cunliffe adds: “They [cryptocurrencies, C.B.] are growing very fast, and they are integrating further and further into what I call the traditional financial system”. The moment when cryptocurrencies can become a danger is approaching.
Therefore, Cunliffe urges regulators and lawmakers to “think very hard about it.” The scenario he worries about is this: Cryptocurrencies become so intertwined with the broader financial system that the high volatility typical of crypto spills over into traditional markets. A hard crash in crypto, as we all know it, could take a broad undertow the next time around.
How much does a crypto crash drag down the financial system with it?
Regulators and lawmakers, Cunliffe urges, need to provide clarity on how they would deal with such a hard crash in the crypto markets. How do they contain such a conflagration? How do they prevent it from spilling over?
Such a collapse is likely because of many factors, the deputy governor already said in a speech on 13 October, such as the lack of intrinsic value, price volatility, herd instinct or operational risks in cyberspace. The central banker even goes so far as to consider a crash to zero-comma-zero, i.e. a total and final collapse, possible. Therefore, he said, one must prepare for it and at least know what risks are involved.
But Cunliffe also warned against overreacting. “We should not see new approaches as dangerous just because they are different.” Innovation introduced new technologies and players; it has historically been key to improving and strengthening finance. “Crypto technologies” offered the prospect of “radical improvements in finance.”
However, current applications – i.e. Bitcoin and other cryptocurrencies – cause him concern for several reasons. First and foremost, because they are currently in the process of rapidly merging with traditional finance in a largely unregulated way. Overseers around the world are applying standard regulations to cryptocurrencies and exchanges, but they don’t always apply – to non-fiduciary wallets, for example, or to DeFi – and they’re often not designed to govern a globally borderless money. It’s a bit like trying to train a dragon with the tools you practice on dogs.
Cunliffe believes the risks posed by crypto are limited at the moment. But they could grow rapidly. How fast and how far would depend on the reaction of regulators and lawmakers.
In his speech, the central banker points out that the bitcoin price has fallen more than 10 per cent on 30 days over the last five years, with a record 40 per cent plunge in March 2020. That such plunges occur is less the exception than the rule, and the question is not if they will happen, but when. But what “can trigger such events if these crypto assets continue to wake up at this pace, if they integrate even further into the traditional financial sector, and if investment strategies continue to become more complex?”
In itself, the financial system should allow for sharp corrections, collapses, as well as large losses from speculative financial products. This is a “necessary feature”. But the supervisor has to make sure that such events do not have a damaging effect on the real economy. Therefore, it must evaluate how high the risks are that this will happen and how to mitigate them.
The IMF sees it the same way
A very similar warning, congruent in places, was also voiced by the International Monetary Fund (IMF) at the end of October. The sub-national institution issued its “Global Financial Stability Report”.
The report devotes an entire chapter to the rise of crypto assets. The IMF also states that crypto does not yet pose systemic risks to financial stability, but notes that “risks should be monitored closely as they can have global consequences and the operational and regulatory framework is not yet adequate in many jurisdictions. “
Like Cunliffe, the IMF notes the tremendous growth of cryptocurrencies. As recently as 2018, the IMF noted that cryptocurrencies posed no threat to the financial system. The phenomenon was far too small. Now it says there is no systemic risk to the stability of the global financial system yet. The adjectives that have crept into the wording are hugely important.
It is true that the crypto ecosystem is still too small to pose a global risk. But crypto assets and “especially stablecoins” can “pose a high risk to emerging markets and developing countries.”
Driving risk, he says, are highly speculative assets – for example, memecoins such as Dogecoin or Shiba Inu – the practice of trading with leverage, sometimes high, and finally DeFi, where products are sometimes complex and opaque and errors in the code can cause high losses. All of this can indeed take unpredictable effects on the crypto markets in the wrong market situation and in combination.
“Still” central banks welcome innovation
This change in tone at both Cunliffe and the IMF is significant. The institutions assert that Bitcoin continues to pose no risk to the stability of global finance. Central banks are still stronger, and a piece of software dumped on the internet by an anonymous developer has not yet managed to knock central banks off their thrones and shake global finance.
But the “yet” sounds increasingly tentative and uncertain. In developing countries, the IMF is already warning that cryptocurrencies and stablecoins are becoming a serious threat, and there should be little doubt that the same will be true for global finance if the ecosystem continues to grow at the same pace. One might almost hope that the bull market will take a little breather at this point and perhaps correct itself.
For the financial establishment recognises the danger that is dawning on it. It is already trying to persuade supervisors and legislators to regulate more strictly, but, at least in the West, it is sticking to welcoming new technologies instead of, like China, preventing innovations if they grow unwanted teeth or wings. But here, too, the “still” applies, and one may doubt that central bankers and politicians will stick to it when things get really dicey for them …
