Crypto links with banks pose a threat to financial stability, says ECB

The crypto industry’s deepening ties with banks and wealth managers will pose a risk to financial stability, the European Central Bank has warned in the latest sign of central banks and governments stepping up their market scrutiny.

The ECB said on Tuesday it had “taken a deep dive into crypto asset leverage and crypto lending” and found evidence that these activities were becoming riskier, more complex, and associated with traditional institutions.

“Investors have been able to cope with the €1.3 trillion decline in the market capitalization of unhedged crypto assets since November 2021 without taking risks to financial stability,” the ECB said. “However, at this rate, a point is being reached where unhedged cryptoassets pose a risk to financial stability.”

The first such warning from the ECB, released as part of its semi-annual financial stability review, followed similar messages from US and UK authorities, who have been unsettled by a string of recent crypto market failures.

Bitcoin, the world’s flagship cryptocurrency, has halved since November and recently fell below $30,000 for the first time since last summer. The market’s main stablecoin, Tether, temporarily lost its peg to the US dollar, while its rival TerraUSD nearly collapsed.

The crypto market itself has boomed in recent years, with major platforms such as Binance and FTX offering a wide range of complex financial products. The world’s largest crypto exchanges processed nearly $700 billion in spot trading and $1.1 trillion in bitcoin futures last month, according to data compiled by The Block Crypto.

The ECB said trading volumes for cryptoassets “were at times comparable to or even exceeding quarterly trading volumes for New York Stock Exchange or euro area government bonds.”

At the same time, some crypto exchanges are offering loans to customers so they can increase their exposure by up to 125 times their initial investment, it said. But “significant information and data gaps persist,” meaning that “the full extent of possible contagion channels with the traditional financial system cannot be fully ascertained.”

ECB President Christine Lagarde said on Dutch television over the weekend that a crypto token is “worth nothing, it is based on nothing, there is no underlying asset that could act as an anchor of safety.” Fabio Panetta, an ECB executive, recently likened the sector to a “Ponzi scheme” and called for a regulatory crackdown to avoid a “lawless frenzy of risk-taking.”

Links between eurozone banks and crypto assets “have so far been limited,” the ECB said in its Tuesday report. The central bank said that some international and eurozone banks “already trade and clear regulated crypto derivatives, even if they do not hold underlying crypto asset inventory.”

It added that major payment networks have “increased their support for cryptoasset services” and institutional investors are “also now investing more broadly in bitcoin and cryptoassets.”

Noting that German institutional investment funds have been allowed to invest up to a fifth of their holdings in crypto assets since last year, it said such investments have been aided by the availability of crypto-based derivatives and listed securities.

The ECB also cited risks from decentralized finance, or DeFi, where cryptocurrency-based software programs offer financial services without the use of intermediaries like banks.

“Crypto loans on DeFi platforms grew by a factor of 14 in 2021, while the total value locked was around 70 billion until recently. limits are exceeded.

According to a recent ECB survey, up to one in ten EU households can “own crypto assets”, although most had less than €5,000 invested in the sector. Similarly, a Fed survey released Monday found that 12 percent of US adults owned or used cryptocurrencies in 2021.

The EU is currently finalizing legislation dubbed markets for crypto assets, but the ECB said they would come into effect in 2024 at the earliest. “Given the speed of crypto developments and increasing risks, it is important to urgently bring crypto assets into the regulatory perimeter and place them under oversight,” it said.

Additional reporting by Scott Chipolina in London

Video: Highlights from the FT Summit on Crypto and Digital Assets | FT Live

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