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Can cryptocurrencies fuel global economic instability?

The entire crypto market capitalization grew by 3.5x in 2021 to $2.6 trillion

Global financial market watchdog Financial Stability Board (FSB) has warned that the present burgeoning crypto valuations can be a hindrance to financial stability as it released its ‘Assessment of Risks to Financial Stability from Crypto-assets’ report.

In a statement, FSB, which is headquartered in Basel, Switzerland, said, “Crypto-asset markets are fast evolving and could reach a point where they represent a threat to global financial stability due to their scale, structural vulnerabilities, and increasing interconnectedness with the traditional financial system.”

The report studied three categories of crypto-assets — un-backed crypto assets (such as Bitcoin); stable coins; and decentralized finance (DeFi).

FSB, which actively scrutinizes financial developments in 24 countries across the globe, said that these three asset classes were intertwined in a complex and ever-changing ecosystem, and they must be viewed as a whole for assessing financial stability threats.

The report noted that the entire crypto market capitalization grew by 3.5x in 2021 to $2.6 trillion but is far from a situation where they should be considered a major financial system asset.

The report further said, “Direct connections between crypto-assets and systemically important financial institutions and core financial markets, while growing rapidly, are limited at the present time.”

However, it added, “If the current trajectory of growth in scale and interconnectedness of crypto-assets to these institutions were to continue, this could have implications for global financial stability.”

Some of the risks highlighted by the report are increasing linkages between crypto-asset markets and the regulated financial system; liquidity mismatch, credit and operational risks that make stable coins susceptible to sudden and disruptive runs on their reserves, with the potential to spill over to short term funding markets; the increased use of leverage in investment strategies; concentration risk of trading platforms; and the opacity and lack of regulatory oversight of the sector.

FSB suggested that even though the extent of crypto-assets usage varies from country to country, there is a need for timely and preemptive policy measures to negate instability.

The report also called for attention to low levels of investor and consumer understanding of crypto-assets, money laundering, cyber-crime, and ransomware.

This report by FSB comes after October. They publish a high-level recommendation for effective regulation, supervision, and oversight of “global stable coin” arrangements.

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