BoE exploring CBDC – but crypto poses financial stability risks: deputy governor

Crypto technologies “offer a prospect of radical improvements in financial services”, but could pose financial stability risks in their current form, according to the Bank of England's deputy governor for financial stability.

Speaking at Sibos 2021, Sir Jon Cunliffe said: “Although crypto finance operates in novel ways, well-designed standards and regulation could and should enable risks to be managed in the crypto world as they are managed in the world of traditional finance.”

Sir Jon explained the Bank’s current thinking on the potential for benefit and risks associated with both unbacked cryptoassets used for speculation and backed cryptoassets, also known as stablecoins.

He also considered market developments including use of leverage with cryptoassets and the growth of decentralised finance (DeFi).

He noted that “the volatility of their value makes unbacked cryptoassets generally unsuitable for making payments – except for criminal purposes”.

But he also acknowledged growing interest in them among institutional investors and hedge funds; and the fact that a number of major banks have launched or are considering offering digital asset custody services, cryptoasset future trading services; and, access to crypto exchange platforms.

Sir Jon also considered the potential impact that a major collapse in cryptoasset prices (“a plausible scenario”) could have on the wider financial system.

While direct losses to investors or banks would not present direct systemic risks, he said that the degree of interconnectedness between the crypto and conventional financial markets is increasing; and suggested that a severe price correction “could trigger margin calls on crypto positions, forcing leveraged investors to find cash to meet them, leading to the sale of other assets and generating spillovers to other markets”.

Contagion in investor risk sentiment could also lead to sell-offs of other types of assets perceived to be high risk.

Highlighting the lack of both transparency and regulation of these assets, he concluded that while such an event would not cause financial stability problems today, “the current trajectory implies that this may not be the case for very long”.

Sir Jon also emphasised the need for regulatory control of stablecoins as they become more commonly used; and hailed the publication last week of a CPMI-IOSCO report on how the Principles for Financial Market Infrastructures (PFMI) standards for payments should apply to stablecoins.

He also touched on DeFi, which he suggested offered regulators “a unique set of challenges” due to its decentralised, global and opaque nature – “pronounced market integrity challenges given the absence of investor protection, AML and other market integrity provisions”.

Sir Jon also said the Bank and other central banks and regulators around the world have been modelling the potential impacts of the introduction of a Central Bank Digital Currency (CBDC).

Earlier in the day, during a discussion panel at Sibos on CBDCs, his colleague Tom Mutton, director with responsibility for CBDC at the Bank, confirmed that it is exploring the potential uses and risks of a retail CBDC.

Mutton explained: “We’re exploring this with great interest, but no decision has been taken yet”, adding that the bank is also carrying out a concurrent review of the potentail uses and risks of a wholesale CBDC that could be used for clearing.

Mutton pointed out that in a sense, wholesale CBDCs already exist, in the form of central bank reserves. “If there are new ways to use reserves … through new technology platforms, then I think that’s a really positive development,” he said. “If a wholesale CBDC is to [enable] better clearing, better settlement, better wholesale payments, that’s a good thing.”

On the same panel, Citibank managing director Tony McLaughlin railed against the term ‘stablecoin’, which he said he considered to be misleading.

“I’d hate to think that consumers … [might] get the impression that these instruments are stable,” he said. “Until they are brought into the regulated environment they have many questions attached to them.”

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