13 October 2021

Bank of England's Cunliffe: Is ‘crypto’ a financial stability risk?

He looks at the impact of ‘crypto’ on the stability of the UK’s financial system. ...unbacked crypto-assets (eg Bitcoin) and backed crypto-assets for payments (stablecoins) have begun to connect to the financial system. ...and talks about how regulators are responding to their rapid growth.

Cryptoassets have grown by roughly 200% in 2021, from just under $800 billion to $2.3 trillion today. They have grown from just $16 billion 5 years ago. $2.3 trillion of course needs to be seen in the context of the $250 trillion global financial system. But as the financial crisis showed us, you don’t have to account for a large proportion of the financial sector to trigger financial stability problems – sub-prime was valued at around $1.2 trillion in 2008^{footnote [1]}.

When something in the financial system is growing very fast, and growing in largely unregulated space, financial stability authorities have to sit up and take notice. They have to think very carefully about what could happen and whether they, or other regulatory authorities, need to act.

At the same time, they need to be careful not to over-react – particularly when faced with the unfamiliar. We should not classify new approaches as ‘dangerous’ simply because they are different. Innovation, technology and new players can tackle longstanding frictions and inefficiencies and reduce barriers to entry. Throughout history, they have been key to driving improvement and to increasing resilience in financial services.

I will give you my conclusions at the outset. Crypto technologies offer a prospect of radical improvements in financial services. However, while the financial stability risks are still limited, their current applications are now a financial stability concern for a number of reasons.

Cryptoassets are growing fast and there is rapid development of new applications for the technology. The bulk of these assets have no intrinsic value and are vulnerable to major price corrections. The crypto world is beginning to connect to the traditional financial system and we are seeing the emergence of leveraged players. And, crucially, this is happening in largely unregulated space.

Financial stability risks currently are relatively limited but they could grow very rapidly if, as I expect, this area continues to develop and expand at pace. How large those risks could grow will depend in no small part on the nature and on the speed of the response by regulatory and supervisory authorities.

I will explain today what lies behind these conclusions and what they imply. First, however, we need to explore what lies behind the ‘crypto’ label in the financial system.

Crypto itself is the underlying technology – the application of cryptographic innovation to the recording and to the transfer of the ownership of assets, often on public networks open to all. Recording and transferring ownership of assets is the bedrock of the financial system’s role in storing value and in making transactions. Crypto technology enables – though it does not require - recording and transfer to take place without the banks or custodians that have historically carried out this function.

Within finance, the crypto label covers a multitude of different innovations in financial assets, markets and services. From a financial stability and from a regulatory perspective, what matters is not the underlying technology but how it is used and for what purpose. In other words, we should not regulate technologies but rather the activities the technology is performing. And in doing so, we need to ensure a consistent approach to risks, regardless of the technology used.

I will not attempt a detailed taxonomy of all the crypto innovations in the financial sector - in all probability a few will have been added by the time I have finished speaking. But in order to discuss the most prominent risks, it is worth breaking them down into unbacked cryptoassets used primarily as speculative investments and backed cryptoassets intended for use as a means of payment. I will also touch briefly on the recent development of decentralised crypto platforms and markets that are beginning to offer a broad range of financial services.

Unbacked cryptoassets

Unbacked cryptoassets make up nearly 95% of the $2.3 trillion. They are essentially non-replicable strings of computer code that can be owned and transferred without intermediaries. Bitcoin, of course, is the most prominent example, but there are now nearly eight thousand unbacked cryptoassets in existence. These have no intrinsic value – that is to say there are no assets or commodities behind them: the value of the cryptoasset is determined solely by the price a buyer is prepared to pay at any given moment....

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