BIS Economists Lay Out Policies For Authorities To Adopt Regarding Crypto  

BIS Economists Lay Out Policies For Authorities To Adopt Regarding Crypto  

The Bank For International Settlements (BIS) has released a bulletin addressing the risks posed by cryptocurrencies. Economists at the central bank-run institution have recommended three policies that authorities worldwide could adopt to better regulate the sector. 

Last week, economists at the Bank For International Settlements (BIS) published a report titled “Addressing the risks in crypto: laying out the options”. The bulletin authored by Matteo Aquilina, Jon Frost and Andreas Schrimpf, discusses the risks associated with crypto assets and the various policies regulators and central banks can implement to address them. 

The report takes recent market events, like the collapse of cryptocurrency exchange FTX and algorithmic stablecoin project Terra USD (UST) which resulted in investors losing billions of dollars, into account. Economists noted that this was not the first time crypto markets have gone through booms and busts, however, no prior bear markets have led to a scenario that has created financial instability of this scale for the industry. 

According to the bulletin, centralised (CeFi) and decentralised (DeFi) protocols that facilitate crypto asset related services are subject to many of the vulnerabilities faced by traditional finance (TradFi), but often to a larger extent. BIS says that these intermediaries rely extensively on leverage and “take on liquidity and maturity mismatches”, in addition to facing severe deficiencies in risk management, indulging in non-regulated business activities and mishandling customer funds. 

“Several business models in crypto turned out to be outright Ponzi schemes. These characteristics, coupled with the huge information deficit customers face, strongly undermine investor protection and market integrity,” read the report. 

To address the risks posed by cryptocurrencies, the authors suggest undertaking objectives similar to the ones taken for TradeFi, to protect consumers and investors; preserve market integrity against fraud, manipulation, money laundering and terrorist financing; and safeguard financial stability. In order to preserve purity of the monetary system, BIS is asking global central banks and countries facing inflation where residents are using cryptocurrencies as a store of value, to consider its three step plan to regulate the instruments. 

The first is to “ban” specific crypto activities, the second is to “contain” and isolate crypto from TradFi and the real economy, and the third is to “regulate” the sector in a manner similar to TradFi. All three initiatives come with its own pros and cons. 

The international financial institution says that by banning cryptocurrencies any potential harm to the financial system would be eliminated and investors would not incur any losses due to misconduct by crypto service providers. However, a major disadvantage to the process would be halting or delaying any innovation that was to come from crypto. BIS notes that authorities would face major challenges enforcing the ban as the decentralised and borderless nature of crypto assets makes the process hard to come by.

The organisation of central banks propose that crypto can be isolated and contained by limiting the flow of funds to and from its connections with traditional finance. This means authorities will have to stop the digital financial assets from being used as a means of payment for goods and services. Although financial institutions like banks and asset managers can be prevented from indulging in the activities, entities with “less constrained investment mandates” and investors in jurisdictions with economic issues could still be lured by the higher returns that crypto assets promise. 

The agency suggests regulating the sector in a way similar to TradFi by applying the same principles and tools. Relevant authorities can start by identifying key economic functions performed by crypto and then assess how regulation could impact them. BIS believes that utilising such an approach would ensure consistency in regulating financial activities performed by both crypto and TradFi. This would help evolve the core of existing regulatory frameworks and also allow responsible actors in crypto to “innovate with regulatory and compliance oversight”. 

The Bank For International Settlements is asking central banks to develop an alternative payment system that is more efficient than crypto. The financial institution run by global central banks is asking its members to introduce faster retail payment systems inspired by India’s Unified Payment Infrastructure (UPI) and Brazil’s Pix, or issue central bank digital currencies (CBDCs) that could help “reduce cost of payments, enhance financial inclusion, bolster integrity of the system and promote user control over data and privacy.”

The BIS economists concluded the report by saying that failures in the crypto markets “have so far not spilled over to the traditional financial system or the real economy”, but warned there is no guarantee that it will not affect the sector in the future as DeFi and TradFi become more intertwined. The organisation is urging authorities to consider a variety of policy approaches and at the same time work to improve the existing monetary system with the public’s best interest in mind. 

Also Check: When Will The Next Cost Of Living Payment Be Made And Who Is Eligible?

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