By Mark McSherry
The European Central Bank has warned that crypto-assets “will pose a risk to financial stability” if the present trajectory of growth continues “and if financial institutions become increasingly involved with crypto-assets.”
In a publication called “Decrypting financial stability risks in crypto-asset markets” the ECB said: “Systemic risk increases in line with the level of interconnectedness between crypto-assets and the traditional financial sector, the use of leverage and lending activity.
“It is important to close regulatory and data gaps in the crypto-asset ecosystem to mitigate such systemic risks.”
The report said: “Crypto-assets lack intrinsic economic value or reference assets, while their frequent use as an instrument of speculation, their high volatility and energy consumption, and their use in financing illicit activities make crypto-assets highly risky instruments.
“This also raises concerns over money laundering, market integrity and consumer protection, and may have implications for financial stability.”
The report said the crypto-asset universe has increased dramatically in both size and complexity since the end of 2020, expanding beyond Bitcoin.
It said that despite recent market developments — the price of Bitcoin and the other main unbacked crypto-assets has more than halved since early November — the overall market capitalisation of the crypto-asset class is still around seven times bigger than it was at the start of 2020, having reached a high of over €2.5 trillion on aggregate in late 2021.
It said that although the crypto-asset universe is still relatively small compared with the biggest stock exchanges — around 10% of STOXX Europe 600 market capitalisation — by November 2021 Bitcoin and Ether were among the largest assets globally.
The publication warned that trading volumes for the most representative crypto-assets — including Bitcoin, Ether and Tether — have at times been comparable with or even surpassed those of the New York Stock Exchange or euro area sovereign bond quarterly trading volumes.
It said there are now more than 16,000 crypto-assets in existence — 10 new crypto-assets are launched every day on average — although only around 25 crypto-assets have a market capitalisation comparable with that of a large cap equity.
At the same time, selected subsegments within the crypto-asset ecosystem such as stablecoins, non-fungible tokens (NFTs) and DeFi grew particularly strongly in 2021, indicating that the potential functionalities of crypto-assets are expanding.
“However, crypto-asset markets also continue to be characterised by high levels of volatility,” said the report.
“Over the last few years, the historical volatility of crypto-assets has continued to dwarf the volatility of the diversified European stock and bond markets.
“For example, while the volatility of the Bitcoin price has declined over the years, it is still significantly higher than for commodities such as silver and gold.
“Despite volatile movements and bouts of speculation, crypto-assets trended upwards throughout most of 2021, leading to all-time-high prices for most individual crypto-assets.
“However, since early November the price of Bitcoin, as well as that of the other main unbacked crypto-assets, has more than halved amid a changing environment (US monetary tightening and increasing geopolitical tensions).”