The fast-evolving crypto-asset markets could one day emerge as a threat to global financial stability, outlined the Financial Stability Board (FSB) in its latest report Assessment of Risks to Financial Stability from Crypto-assets. It says the scale, structural vulnerabilities, and increasing interconnectedness with the traditional financial system could take a toll.
The crypto-asset market capitalization grew by 3.5 times in 2021 to $2.6 trillion, but it remains a small portion of the overall global financial system assets. The report noted that direct connections between crypto-assets and financial institutions, and core financial markets are limited at the present time. But institutional involvement in crypto-asset markets has grown significantly over the last year. If this continues, it could have implications for global financial stability.
In regards to decentralized finance (DeFi), the report described it as a fast-emerging sector providing financial services through unsupported crypto-assets and stable coins. Some DeFi platforms operate outside of a jurisdiction’s regulatory perimeter, and some are not in compliance with applicable laws and regulations. This shows the potential for the concentration of risks. It also underscores the lack of transparency in their activities.
The report highlights that the stable coin market has continued to grow despite concerns about regulatory compliance, quality, and sufficiency of reserve assets. Presently, stable coins are used as a bridge between traditional fiat currencies and crypto-assets. This has implications for the stability and functioning of crypto-assets markets.
FSB said if a major stable coin fails, it is possible that liquidity within the broader crypto-asset ecosystem becomes constrained. This could disrupt trading and cause stress in those markets. It is likely to spill over to short-term funding markets if stable coin reserve holdings were liquidated in a disorderly manner.
Furthermore, the report highlighted a number of vulnerabilities associated with crypto-asset markets. It included increasing linkages between crypto-asset markets and the regulated financial system, liquidity mismatch, credit, and operational risks, and increased use of leverage in investment strategies.