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Digital Currencies Pose An Increasing Risk To Financial Stability

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A global financial stability watchdog has raised the alarm about crypto assets, saying that they might represent a substantial risk to the broader financial system if they remain unregulated.

In a study released on Wednesday, the Financial Stability Board (FSB) stated that risks such as regulatory loopholes, fragmentation, and arbitrage could exist. “rapidly escalate, underscoring the need for timely and pre-emptive evaluation of possible policy responses.”

The paper investigated the vulnerabilities associated with crypto assets such as unbacked coins (such as bitcoin), stablecoins, and decentralized finance (DeFi).

The FSB specifically targeted stablecoins, which are crypto assets that are pegged to a commodity or currency, implying that their footprint has grown dramatically despite worries about regulatory compliance and the extent of reserve assets held to back them. It’s a worry that has trailed stablecoin behemoth Tether, as the corporation has been known to conceal where its reserves are kept.

According to the paper, the nature of these currencies exposes them to liquidity mismatches, as well as credit and operational concerns, making them more vulnerable to disruptive runs on their reserves. Stablecoins, in particular, are now acting as a link between traditional fiat currency and cryptocurrencies.

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“Were a major stablecoin to fail, it is possible that liquidity within the broader crypto-asset ecosystem (including in DeFi) could become constrained, disrupting trading and potentially causing stress in those markets,” the report read. “This could also spill over to short-term funding markets if stablecoin reserve holdings were liquidated in a disorderly fashion.”

These worries come as the crypto asset market size is expected to grow 3.5 times to US$2.6 trillion by 2021. According to the FSB, banks and financial institutions that are critical to system stability are increasing their exposure to cryptocurrencies as they incorporate them into their business models through products ranging from exchange-traded funds to complex derivatives and other leveraged investment products.

“If the current trajectory of growth in scale and interconnectedness of crypto-assets to these institutions were to continue, this could have implications for global financial stability,” the report read.

This report comes as Canada increases inspection of cryptocurrency transactions as part of new rules adopted as part of the federal government’s Emergencies Act, which was triggered Monday in response to blockades that have slowed trade with the United States at multiple border crossings.

Cryptocurrency frauds have also caused market observers to be concerned. According to a research from crypto analytics firm Chainalysis, crypto rug-pull scams took in over US$2.8 billion in criminal activity last year.

The FSB also stated that it would continue to monitor these assets and guarantee that recommendations to award assets sufficient control are carried out.