Financial stability risks for Bitcoin (BTC) and other cryptocurrencies are rising, the European Central Bank (ECB) said in the latest version of its macroprudential bulletin. Top banks are also pointing their searchlights to centralisation of decentralised finance (DeFi), stablecoin risks and the environmental impact of proof-of-work (PoW) mining.
ECB macroprudential Report
In the July edition of the European Central Bank's (ECB) macroprudential bulletin, researchers at the 24-year-old top-ranked bank pointed their searchlights at cryptocurrencies, staboins, and decentralized finance (DeFi).
The ECB has long viewed blockchain-based cryptocurrencies such as Bitcoin (BTC), Ether (ETH) and other knock-off coins as a huge threat to the traditional financial system, and reiterated that position in its latest report.
The researchers believe that the exponential growth witnessed by the industry to date, coupled with the interlinkages between cryptocurrencies and traditional financial systems brought about by increased institutional interest, has significantly increased the financial stability risks of digital assets. Therefore, the EU authorities must strengthen their supervision of this area.
"Financial stability risks from crypto assets are rising and could reach systemic thresholds. A recent analysis by the Financial Stability Board (FSB) and the European Central Bank shows that the nature and size of the crypto asset market is developing rapidly. If current trends continue, crypto assets pose a risk to financial stability. Therefore, crypto markets need to be effectively regulated and supervised, "the ECB said.
Stabecoin, DeFi and PoW mining
In February 2021, the ECB urged the region's lawmakers to develop rules that would bring stablecoin issuance in the region under its absolute control. The sudden collapse of the Terra USD stablesoin in May, and the subsequent decoupling of other stablesoins from the DOLLAR, has brought more regulatory scrutiny to these so-called stablesoins.
Now, the ECB says that while stabocoins account for only 10% of the total market capitalization of cryptocurrencies, they have gone from merely hedging against negative volatility in the crypto market to becoming a significant part of the crypto industry, as they are often used in exchange pairs for Bitcoin and copycoins and to provide liquidity for DeFi protocols.
According to the ECB, collaterized staboins such as Tether (USDT), USDC, and Binance USD account for about 90% of the total staboins market, and the total volume of these staboins will surpass that of unsecured cryptocurrencies in 2021 to reach 2.96 trillion euros. Almost as much as New York Stock Exchange stocks (3.12 trillion euros).
In this context, the ECB said that stablecoins could pose risks to financial stability through various channels of contagion, including financial sector exposure, wealth effects (i.e., the extent to which a collapse in the stablecoin's value could affect its investors), And subsequent shocks) on the traditional financial system), confidence effects (i.e., the extent to which negative developments regarding crypto assets may affect investor confidence in crypto and potentially the broader financial system), and the extent to which staboins are used in payments and settlement.
"Issuers of collectable stablecoin need to ensure sound reserve asset management to instill confidence, ensure the stability of the peg and avoid a run on tokens that could spread to the financial sector," the ECB noted. The cross-border nature of the Stablecoin and a refined and robust global regulatory approach are essential."
The researchers also outlined some of the risks inherent in the decentralized finance (DeFi) sector, including governance and operational risks, and highlighted the need for industry regulation.
The ECB report decried the energy-intensive use of PoW cryptocurrencies like Bitcoin (BTC). It also argues that the transition from PoW mining to renewable energy "could crowd out other uses of renewable energy, putting countries' green transition goals at risk."