The collapse and bankruptcy of the crypto exchange FTX, as well as the subsequent sell-off in the crypto asset market, have highlighted the crypto ecosystem’s inherent vulnerabilities. Binance, the largest cryptocurrency exchange, recently prohibited stablecoin withdrawals from its platform. The failure of TerraUSD/Luna, an algorithmic stablecoin, a run on Celsius, a crypto lender, and the bankruptcy of Three Arrows Capital, a cryptocurrency hedge fund, all preceded the implosion of FTX
RBI has released Twenty Sixth Edition of Financial Stability Report (FSR) for 2022. Report highlights the inherent risk in the Crypto Assets, its co-relation with Equity Market, systemic risk it poses to Global Financial System and need for Regulation.
The report highlights the collapse of TerraUSD/Luna and serves as a reminder that so-called stablecoins, which promise to maintain a stable value relative to fiat currency, are vulnerable to classic confidence runs. The failure of FTX and Celsius demonstrates that crypto exchanges and trading platforms were performing various functions such as lending, brokerage, clearing, and settlement, all of which carry different risks in the absence of appropriate governance structures.
The latest Systemic Risk Survey (SRS) from the Reserve Bank revealed that global spillovers, financial market and general risks have increased, while macroeconomic risks have moderated. There is no discernible change in institutional risks. The major contributors to risk are cited as monetary tightening in advanced economies, tightening financial conditions, geopolitical risks, global growth uncertainty, climate change and risks from private cryptocurrencies.
On the Global Financial Stability, report highlights that monetary tightening, Debt stress, currency volatility, turmoil in crypto assets market and growth of open-ended funds are some of the major risks that can potentially undermine global stability.
The report draws attention to the Financial Stability Board’s (FSB) proposal for a framework for international regulation of crypto asset activities. The market volatility of crypto assets highlights their inherent volatility and structural vulnerabilities, while their interconnectedness with the traditional financial system grows. Its recommendations aim to promote international consistency in regulatory and supervisory approaches based on the “same activity, same risk, same regulation” principle.
According to the framework, authorities should have appropriate powers, tools, and resources to regulate, supervise, and oversee crypto asset activities and markets, both domestically and internationally, in proportion to the financial stability risk they pose. The recommendations also include, but are not limited to, promoting comprehensive governance and effective risk management frameworks, addressing financial stability risks associated with interconnectedness, and developing an appropriate disclosure framework.
The Basel Committee prescribed a global minimum prudential treatment for banks’ exposures to crypto assets to mitigate risk, which was endorsed by the Governors and Heads of Supervision (GHOS) on December 16, 2022. Banks are required to classify crypto assets into two distinct groups on an ongoing basis under the new standard. Those in Group 2 will be subject to newly prescribed conservative capital treatment beginning January 1, 2025.
Group 1 will consist of tokenized traditional assets. It will also include those that have effective stabilisation mechanisms and are subject to capital requirements based on the risk weights of underlying exposures as defined by the existing Basel Framework. Group 2 will include those who pose greater risks than Group 1.
The new standard describes how the operational risk, liquidity, leverage ratio, and large exposure requirements would be applied to banks’ exposure to crypto assets.
The collapse and bankruptcy of the crypto exchange FTX, as well as the subsequent sell-off in the crypto asset market, have highlighted the crypto ecosystem’s inherent vulnerabilities. Binance, the largest cryptocurrency exchange, recently prohibited stablecoin withdrawals from its platform. The failure of TerraUSD/Luna, an algorithmic stablecoin, a run on Celsius, a crypto lender, and the bankruptcy of Three Arrows Capital, a cryptocurrency hedge fund, all preceded the implosion of FTX.
Several insights have emerged as a result of the upheaval. To begin with, crypto assets are extremely volatile. Bitcoin’s price has dropped 74% since its peak in November 2021 (as of December 14, 2022). Other crypto assets have seen similar price drops and increased volatility. Crypto assets have strong correlations with equities. Furthermore, despite claims that they are an alternative source of value due to inflation hedging benefits, the value of crypto assets has fallen even as inflation has risen.
Although crypto assets market remains volatile, there have not yet been any spill overs onto the stability of the formal financial system. Report highlights the RBI view on Crypto that Crypto form an unstable ecosystem. Report elucidate that with failure of Crypto firm, it becomes more evident that crypto remain highly concentrated and interconnected. To address potential future financial stability risks and to protect consumers and investors, it is important to arrive at a common approach to crypto assets.
Although the crypto asset market remains volatile, there have been no spillover effects on the stability of the traditional financial system. However, historical evidence suggests that they form an unstable ecosystem, and there is mounting evidence that they remain highly concentrated and interconnected. In its report, RBI has recommended that to address potential future financial stability risks and protect consumers and investors, a common approach to crypto assets is required.