In light of the latest events that have shaken the crypto sector, the Bank for International Settlements (BIS) issued new recommendations to help regulators define what steps to take to prevent similar incidents from threatening financial stability. Indeed, the authors of the document believe that the risks posed by the cryptocurrency industry must be eliminated before they become systemic and spread to the entire financial sector.
In a new research paper, the BIS cited possible approaches to addressing the risks posed by crypto-assets. These three approaches are: regulate, contain or completely ban the industry. The BIS has also suggested a fourth approach which is to use central bank digital currencies (CBDC).
Limit the negative impact of incidents in the cryptocurrency industry
The BIS believes that cryptocurrencies have similar risks to traditional finance (TradFi), however these risks tend to be exaggerated. These include the extensive use of leverage, liquidity and maturity mismatches, and significant information asymmetries. Regulation would take place through the establishment of measures similar to those in the financial services sector. The challenge with this approach is to establish an adequate match between crypto assets and entities and their TradFi counterparts, as well as the corresponding legal basis. Furthermore, the success of this approach relies on the identification of entities that will serve as entry points for regulation. This task is difficult due to the absence of clear points of reference, be they companies or individuals.
The second approach advocated by the BIS aims to ensure that interactions with traditional finance are kept to a minimum. It may be possible to prevent banking institutions and some asset managers from becoming a conduit to facilitate crypto business, in line with the approach followed by the Basel Committee on Banking Supervision. The BRI took the example of the Securities and Exchange Commission American, which has so far refused to authorize an exchange-traded fund (ETF) based on the spot Bitcoin markets. However, the question of investor protection and market integrity continues to arise. And the BIS believes the credibility of regulators could be called into question if no action is taken to protect crypto investors.
Banning cryptocurrencies would be an “extreme option” that would limit innovation. The BIS has acknowledged that it is difficult to ban decentralized businesses without borders. On the other hand, imposing restrictions on centralized intermediaries would be more effective, but could drive them to another jurisdiction.
The BIS stressed that these three approaches could be combined depending on the risks perceived by regulators in each country.
A recommended alternative: CBDCs
At the same time, one of the BIS recommendations would be to improve the attractiveness of traditional finance and an important element of that strategy would be to improve the quality and reduce the cost of payments.
To this end, a possible option would be to introduce fast payment systems for individuals, such as Unified Payment Interface (UPI) in India, Pix in Brazil, the future FedNow system in the United States or initiatives such as the Single Euro Payments Zone (SUPE). . The other alternative proposed by the BIS is the issuance of central bank digital currencies (CBDCs) that meet real needs. If implemented correctly, these initiatives could support strong private sector innovation.
Given their central role in the economic and financial system, central banks are naturally well positioned to encourage this innovation.
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