The European Central Bank on Wednesday called on European politicians to speed up the adoption of legislation that would restrict the cryptocurrency market. Like other international regulators, the ECB is increasingly concerned about the risks to the financial stability of crypto investments. These are still largely unregulated worldwide.
Given the “speed of development” and the “rising risks”, it is important to bring the crypto sector “inside the regulated zone and under supervision”, according to the ECB in its annual analysis on financial stability. According to the central bank, this is an “urgent matter”.
As one of the first international regulators, the European Union is working on legislation for crypto trading. A regulation proposed by the European Commission, which among other things obliges crypto providers in the EU to obtain a licence, is the subject of negotiations between the European Parliament and the Member States. The regulation can only come into effect from 2024, the ECB notes impatiently.
The instability of the crypto world became apparent earlier this month when TerraUSD, a popular stablecoin, collapsed. A stablecoin is a coin whose value is – in theory – pegged to real currency, usually the dollar. That link (1 TerraUSD = 1 dollar) turned out not to work. The collateral, partly consisting of bitcoin, was insufficient to keep the value equal to that of the dollar. Market confidence evaporated and TerraUSD is now worth only 7.5 cents.
Worrying about stablecoins
Stablecoins are a growing concern for regulators as they form a bridge to the mainstream financial system. Collapsing stablecoins could therefore cause wider financial instability. Stablecoins are often used for transactions within the crypto world and between cryptocurrencies and the traditional banking system. The ECB points to the vulnerability of the most widely used stablecoin worldwide: tether. Tether is under pressure, partly due to the TerraUSD debacle. Investors pulled in $10 billion this month back from the coin† The tether’s peg to the dollar will hold for now.
The Financial Stability Board (FSB), a major global supervisory body, recently pointed to the increasing entanglement of the crypto world with that of banks and asset managers. For example, banks invest in cryptocurrencies or derivative financial products. The risks to financial stability could therefore “escalate quickly”, according to the FSB, which is currently chaired by Klaas Knot, the president of De Nederlandsche Bank.
G7 points to FSB
Politicians and regulators point at each other: the finance ministers of the G7 countries shouted last weekend the FSB for “rapid development and implementation” of crypto sector regulations.
Policymakers seem taken aback by the explosive growth of the sector. The ECB gives some figures. Despite the recent, significant price losses of cryptocurrencies (bitcoin has lost more than half of its value since November), the market value of all crypto investments is seven times as large as it was at the beginning of 2020. All together, this amounts to about 1,000 billion euros. That is less than 1 percent of the global financial system. However, the ECB notes subtly: the size is comparable to that of the fragmented junk mortgages that led to the global financial crisis in 2007-2008. A subtle way of saying that the next financial crisis could also arise from a crypto crash.
What the junk mortgages have in common with the crypto world is the lack of transparency. The ECB report states that a “significant part” of crypto trading takes place out of the view of regulators anyway. The information provided by crypto investment providers (and also trading platforms) is “unverifiable”.
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‘Crypto is worth nothing’
ECB President Christine Lagarde told the TV program College Tour on Sunday that in her “humble opinion” cryptocurrencies are “worth nothing”. “It’s not based on anything, there’s no underlying asset that acts as a safety anchor,” she said. During the broadcast, a student told how he recently lost thousands of euros on his crypto investment. The Dutch are relatively happy to invest in crypto, according to the ECB report. About a tenth of households in six euro countries together (Germany, France, Italy, Spain, Netherlands, Belgium) own cryptos. In the Netherlands this is almost 15 percent.