UK and US Take Differing Stances in Assessing the Financial Stability Risks of Cryptocurrencies

Recent statements by representatives of the Bank of England, the President’s Working Group on Financial Markets, and the Financial Stability Board (FSB) suggest that consensus on the potential of cryptocurrencies to put the stability of financial systems at risk is diverging, at least in emphasis.

In the US, the President’s Working Group on Financial Markets, together with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, released a report in which it claims an urgent need to regulate stablecoins and the entities that issue them. The potential risks raised by the group include payment system disruption, concentration of economic power, and destabilising runs. This is the next in a series of attempts by the US to regulate systemically important parts of the digital asset industry, and this approach particularly highlights a focus on regulating the environment in which digital assets function, rather than regulating the assets themselves.

In contrast, in a speech at SIBOS, Bank of England deputy governor for financial stability Sir Jon Cunliffe stressed that, while the risks that cryptoassets pose to the financial system are now ‘relatively limited’, that assessment may change rapidly. This marks a shift in attention from addressing stablecoins as a first priority towards a broad-brush approach to the digital asset class as a whole. Cunliffe’s key point was that the USD 2.3 trillion market value of cryptocurrencies today may comprise a relatively small part of the total USD 250 trillion global financial system, but it could more than suffice to cause issues given the lesson of the USD 1.2 trillion sub-prime mortgage sector in 2008. Crypto technologies could offer ‘radical improvements in financial services’ but are already a concern. Cunliffe underlined the fact that policymakers around the world have only just begun to develop a framework appropriate for digital assets but they should pursue it ‘as a matter of urgency’.

Cunliffe’s comments were echoed by Bank of England Deputy Governor Sam Woods, Chief Executive Officer of the Prudential Regulation Authority, who stated a willingness to ‘front-run’ regulation – i.e. to lead global regulatory efforts rather than wait for a consensus to emerge – in order to prevent UK banks from accumulating over-large exposure to cryptoassets without supporting capital. Referring to recent Basel Committee proposals to apply a risk weighting of 1,250% in setting the capital backing for cryptocurrency holdings, translating into requiring capital at least equal in value to them and disregarding banks’ ability to hedge exposures. Woods said that UK rules may not exactly match the Basel Committee approach, but that they would be ‘very conservative’.

The announcement is another example of a change in attitude by an important public entity, as only 5 months ago BoE governor Andrew Bailey stated, ‘If consumers invest in these types of product [cryptocurrencies], they should be prepared to lose all their money.’

In marked contrast, the Financial Stability Board’s Patrick Armstrong presented a view at September’s Global Digital Finance Summit that cryptoassets – while on the radar and growing in value – are still too small to cause concern for global financial stability. His view is predicated on the asset class remaining relatively insignificant in proportion to total financial assets, real assets, and household wealth. The FSB acknowledges the risk that investor confidence in cryptoassets could be damaged through volatility, fraud, theft, or operational failures, but believes this is unlikely to affect overall stability. Use cases for cryptocurrencies remain niche, although monitoring is warranted due to a lack of the systemic safeguards built into fiat currencies and other assets.