14th Oct 2021 by Graham Buck

Cryptocurrencies should be regulated as "a matter of urgency" as the potential for a crash risks spreading financial contagion, the Bank of England has warned.

Speaking at an industry conference, the BoE's deputy governor, Sir Jon Cunliffe, said that although a collapse in the market for digital currencies appeared unlikely in the near term that situation could change and regulation was needed. "Regulators internationally and in many jurisdictions have begun the work. It needs to be pursued as a matter of urgency," he told delegates.

Drawing a parallel between the growth of cryptocurrencies and the spiralling value of US sub-prime mortgages in the run-up to the 2008 financial crash, Sir Jon said there was a risk that within a few years an event of similar magnitude could impact on the financial markets.

Noting that the estimated value of the cryptocurrency market has grown over five years, from US$16bn to nearly US$800bn at the start of 2021 and has since grown to US$2.3trn, he added: “Of course US$2.3trn needs to be seen in the context of the US$250trn 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 about US$1.2trn in 2008.”

Breaking up the party

Commenting on the speech, Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown wrote: "Regulators have been tip-toeing round the crypto world, shouting out occasional warnings to the crowds of speculators, but we now have the firmest indication yet that they will soon be stepping in to break up the block party."

With banks and hedge funds now becoming involved in the rapid growth of unregulated crypto assets, the BoE was evidently worried by the possibility of contagion if the value of coins and tokens held deflates rapidly, she added.

Shared concerns

Streeter said that the BoE's warning follows a similar call to action last month from the chairman of the Financial Conduct Authority, Charles Randell. "The FCA is extremely worried about the collision between social media and the crypto world. Now, this nervousness about how financially vulnerable younger investors are being targeted by influencers has widened to an anxiety that the crypto wild west could undermine the stability of the financial system. There has been a hesitancy until now to bring crypto currencies into the regulatory sphere because of the risk it will add more legitimacy to the currencies."

Central banks and regulators evidently regarded stable coins, pegged to fiat currencies such as the dollar as the acceptable alternative to the many coind and tokens in the crypto space "but they currently only make up around 5% of crypto assets held. The Bank of International Settlements, a global forum for central banks has already set out how clearing and payments services should be applied to stable coins.

"There appears to be increasing backing of recommendations made by the influential Basel Committee on Banking Supervision. If banks and other regulated financial institutions dabble in crypto, the committee is considering making them put aside enough capital to cover 100% of potential losses," Streeter concluded. "Giving speculative tokens a high-risk price tag is likely to make crypto currency dealing and investment very expensive and could limit the number of new institutional entrants into the crypto world."