Cryptos under pressure as regulators call for stricter supervision

Following recent turmoil, regulators and policymakers are looking to ensure financial stability and protect investors by enhancing regulation in the crypto sector. 

According to the G7 group, although the spillover from crypto markets to traditional financial markets remains limited, there remains an urgent need for the “swift development and implementation” of consistent and comprehensive regulation for crypto-asset issuers and service providers. This should be done with a view to holding crypto-assets to the same standards as the rest of the financial system.

Similar sentiments were echoed by the Bank for International Settlements (BIS). In a recent paper it argued that the crypto sector was increasingly used for speculation by unsophisticated retail investors and that the lack of crypto adoption by traditional banks had caused the growth of a “shadow crypto-financial system” in which crypto-exchanges held a dominant yet largely unregulated role.

The bank added that “compared to existing regulated exchanges for ‘traditional’ financial assets, the regulatory and supervisory oversight of crypto-exchanges — encompassing consumer protection, market integrity, trading, disclosure, prudential, and addressing anti-money laundering, combatting the financing of terrorism — remains patchy at best.”

The BIS concluded by saying that “crypto intermediaries… should be subject to the same types of regulation and oversight as intermediaries in economically equivalent asset classes. The purportedly decentralized nature of cryptocurrencies does not negate the need for these critical public policy functions.”

What regulations will come into force?

Regulatory bodies are currently aware of the risks that cryptos could pose to the broader financial system. To counter any future risks, the BIS paper proposed enhancing the collection and publication of cryptocurrency trading data in a more rigorous manner, such as through “embedded supervision”.

Similarly, the BIS paper also warned that stablecoins could pose a systemic threat to the broader financial system. The bank argues that if associated risks remain unaddressed, the evolving crypto landscape would see conventional and regulated intermediaries increasingly linked to an unregulated financial system.

Due to this, the BIS believes that the fundamental policy choice was to either focus on a framework that allowed such interlinkages but enforced a more level playing field with regard to the regulation and supervision of financial services, or to limit the level of interlinkage between the two systems.

“Separating both systems could prove challenging at a global level, making the former solution inevitable,” according to the paper. “Initiatives to promote regulatory clarity on the treatment of these potential exposures… could help to ensure a more level playing field and ensure the prudent management of risks from a microprudential and macroprudential perspective. In practice, this would mean applying more stringent regulatory and supervisory oversight of crypto-exchanges with regard to the provision of financial services… while applying a conservative bank prudential regulatory treatment for cryptocurrency exposures.”

When will new regulations and oversight come into force?

Despite warnings from the G7 and the BIS, new regulations and supervisory powers are not imminent. For example, in the UK, the chair of the Financial Conduct Authority recently stated that the regulator was not ready to take over the supervision of the UK’s crypto sector. This news comes in spite of the fact that the UK’s government recently stated that it wishes to create a world-leading market for crypto assets.

On top of this, other regulators and supervisory bodies have pointed towards the fact that data shortcomings in the sector are also hindering the assessment of financial risks.

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