International standard setters are closing in on cryptoassets and their interventions are likely to intensify in the regulated sphere of the financial services industry, but that is not necessarily bad news for banks. 

What is happening?

The explosive growth in the popularity of cryptoassets and decentralised finance (DeFi) was always going to catch the attention of international standard setters (ISSs). Cryptocurrencies, such as bitcoin, stablecoins backed by fiat currencies and DeFi could have momentous consequences for the financial system. 

Reg rage – acceptance

One of the earliest to kick off was the Financial Action Task Force (FATF) with a consultation in March. FATF focuses on money laundering, with many policy-makers believing that cryptocurrencies are a criminal’s paradise. 

Some in the crypto industry are critical that FATF has so broadly defined virtual assets and virtual asset service providers. If that stands, that will drag a bigger chunk of the industry into anti-money laundering rules. 

Then the Basel Committee on Banking Supervision launched its own consultation on June 10, where it recommended the highest available risk weighting (1250%) for bank exposures to cryptocurrencies, and even capital add-ons for certain types of asset-backed stablecoins due to operational risks. 

But on June 23, the Bank for International Settlements (BIS) dropped a bombshell by dismissing cryptocurrencies as “speculative” and stablecoins as an “appendage”.

And that was just the warm-up.

In its report, the BIS accused bitcoin of facilitating money laundering and ransomware attacks, said that it had few “redeeming public interest attributes” and decried it as an energy hog (due to the highly energy-intensive process of bitcoin mining). 

The BIS was condescending about stablecoins, saying they are not even proper currencies as they rely on the credibility of the real thing. It warned they could fragment liquidity and are merely an appendage to the monetary system. This is very strong language, and the BIS has clearly taken the threat to fiat currencies and central bank sovereignty very seriously.

The bank is highly influential, suggesting that ISSs are going to get tough on crypto and central banks, in particular, do not want their fledgling digital currency initiatives undermined by the wild frontier of finance. 

Why is it happening? 

Policy-makers are concerned that central banks and fiat currencies could be usurped by crypto. They have responded with central bank digital currency (CBDC) initiatives, which mimic some aspects of cryptocurrencies, but remain firmly under centralised control. 

They are also prepared to regulate crypto more strictly to stop the ‘crypto barbarians’ from upending the financial system. Among the big jurisdictions, China has gone furthest with its own CBDC and in steadily strangling cryptocurrencies. The US’s approach is muddled, with various agencies at odds on regulating cryptoassets. Meanwhile, some high-profile lawsuits have sent confusing messages about what is permissible in the US. The EU has taken a clearer approach, sensing an opportunity to foster a tech revolution on its home ground. Though permitted, crypto activities will be quite strictly regulated. Some smaller jurisdictions are taking a liberal approach to crypto, but what really matters is what the big jurisdictions and the ISSs decide upon.  

What do the bankers say? 

Bankers see plenty of opportunities to reduce costs and to develop new revenue streams. They are mainly concerned that supervisors do not overly regulate it, so as to kill off any chance of making money from it. If implemented, the Basel Committee recommendations will already make it difficult for banks to directly hold cryptocurrencies, meaning they will either do it via special-purpose vehicles or just offer custodial and trading services to their clients.

CBDCs would also reduce the need for stablecoins unless for very specific purposes, such as involving programmable functions or being backed by non-currency assets, for example, such as equities. 

On the other hand, banks are geared towards dealing with regulation, while many of the crypto natives are not. This will level the playing field in favour of the banks; however, some crypto firms, which are seeking to become regulated, will establish themselves in the formal financial sector and give the traditional players a good run for their money. 

Will it provide the incentives?  

Crypto presents opportunities and risks — and as always with innovation, it requires policy-makers to strike the right balance. The problem is that the cryptocurrency space is evolving so quickly, making it difficult for policy-makers to keep pace. 

The EU is taking a prescriptive approach when a principles-based one might be more appropriate. Overall, supervisors could misjudge certain developments, which could have unintended consequences. Whatever comes, it will be heavily influenced by the ISSs. One side benefit of that is that it might harmonise the many national crypto rules. 

In-depth insight into global regulation can be found in The Banker’s sister publication Global Risk Regulator.

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