There is a fear that the turmoil seen in cryptocurrency markets such as bitcoin and ethereum will spill over into traditional financial markets and the real economy according to a new paper – Crypto-assets and their risks to financial stability – from the European Securities and Markets Authority (ESMA).
The lack of legislation also poses challenges. “Due to their volatile growth cycles, and as long as relevant regulatory provisions do not apply, crypto-assets entail numerous risks which may in future become relevant for financial stability,” the European watchdog said.
It added, “Multiple transmission channels between the crypto market and the traditional financial system exist,” the document said. “However, their scale remains limited at this time.”
The paper cites an April survey by regulators showing that, just 90 European investment funds had direct exposure to crypto, with a further 20 exposed indirectly via derivatives – a Proverbial drop in the ocean of the bloc’s 60,000 funds.
Until recently, instability in the crypto-assets market – most of which may be traced to intrinsic flaws in the market structure and underlying technology – has not spread to traditional financial markets or the actual economy.
However, spill overs are possible, depending on how current risks are contained and how the interconnections between the two systems develop.
Officials warned that situation could change rapidly – citing auto maker Tesla, which last year said it would accept payments for its products in bitcoin before reconsidering, with both decisions affecting the price of the asset.
They are also worried about repeating many of the risks which occur in traditional financial markets – such as price manipulation and mis-selling, citing exchanges such as Huobi and Bybit that allow risky bets via leverage of over 100 times.
“ESMA shines a light on how the crypto market needs clear standards and oversight to ensure good actors can innovate safely,” said Anoushka Rayner, head of growth commodities at Paxos.
She added, “What traditional market participants could benefit from is the tokenization of real-world assets. Market participants need to collaborate with crypto providers that are regulated.”
ESMA is not the only financial regulator concerned about crypto’s impact on traditional financial institutions.
Christine Lagarde, president of the European Central Bank (ECB), has noted that the expansion of cryptocurrencies might threaten the existing banking system.
In the US, Federal Reserve governor Michelle Bowman highlighted concerns about several cryptocurrency-related issues that she believes poses risks for the banking industry and raise doubts about their regulatory oversight.
