The European Central Bank (ECB) said on Tuesday that cryptocurrencies will pose a risk to financial stability if the nascent sector maintains its rapid growth in the past two years and financial firms deepen their involvement.
The cryptocurrency market has fallen sharply this month after the collapse of the main “stable” terraUSD. The collapse has led to calls from the world’s top financial leaders for “rapid and comprehensive” regulation of the sector.
Cryptocurrencies – historically a niche asset favored by risk-hungry investors, their volume exploded during the COVID-19 pandemic. Institutional investors have been particularly drawn to claims that Bitcoin acts as a hedge against inflation and provides high returns in the face of low interest rates.
The crypto sector peaked at $2.9 trillion last November from less than $300 billion at the start of 2020. However, bitcoin, the largest token, has more than halved since November, bringing the value of the overall crypto market down by as much as Nearly $1.2 trillion.
The European Central Bank said in its semi-annual Financial Stability Review that large-scale exposure of banks and other financial institutions to cryptocurrency could put capital at risk and damage investor confidence, lending and financial markets. “Systematic risks increase in line with the level of interdependence between crypto assets and the traditional financial sector,” she said.
The European Central Bank noted that the highly leveraged trading offered by cryptocurrency exchanges has resulted in investors borrowing money to purchase greater exposure to cryptocurrencies, which also increases financial stability risks.
Moreover, data shortcomings in the sector also hamper the assessment of financial risks, she said, warning that publications issued by cryptocurrency exchanges and data aggregators should be treated with caution.
The European Central Bank noted that retail investors, who have long been at the heart of cryptocurrency trading, have also piled in.
One in ten households in the eurozone has bought digital currencies such as bitcoin, Consumer Expectations Survey, which conducted the survey in six countries.
The European Central Bank said crypto was not suitable for most retail investors and urged EU authorities to approve new rules on crypto assets “as a matter of urgency.”
The European Central Bank said the rules, first published in September 2020, have not yet been approved by the European Union, and are not set for approval until 2024 at the earliest.