Federal Reserve Vice Chair Lael Brainard delivered a speech today for the Bank of England. The topic of discussion was crypto-assets and financial stability, currently a hot subject.
Recently, digital asset markets have floundered causing several firms to cease operations. Tanking valuations have raised fears of crypto contagion. This week, Voyager Digital filed for bankruptcy protection as crypto hedge fund Three Arrow Capital defaulted on a loan valued at over $650 million.
Brainard noted that digital asset markets were currently not large enough to create systemic risk but clearly the ecosystem is in dire need of greater regulation. Brainard said there is a need to distinguish between “responsible innovation and regulatory evasion.”
To quote the Vice-Chair:
“… new products and platforms are often fraught with risks, including fraud and manipulation, and it is important and sometimes difficult to distinguish between hype and value. If past innovation cycles are any guide, in order for distributed ledgers, smart contracts, programmability, and digital assets to fulfill their potential to bring competition, efficiency, and speed, it will be essential to address the basic risks that beset all forms of finance. These risks include runs, fire sales, deleveraging, interconnectedness, and contagion, along with fraud, manipulation, and evasion. In addition, it is important to be on the lookout for the possibility of new forms of risks, since many of the technological innovations underpinning the crypto ecosystem are relatively novel.”
Regulation is good for innovators as it creates confidence in markets.
Brainard notes that Bitcoin has lost over 70% of its value from its all time high and TerraUSD, a crypto that claimed to be a stablecoin but was anything but stable, cannot use financial engineering to “convert risky assets into stable ones.”
While crypto frequently attempts to brand itself as different from old finance, the claim has gone stale as the risks remain the same and unregulated outcomes have become predictable. Over leverage, counter party risks and runs on the banks are the same issues TradFi has been dealing with since the beginning of time.
Brainard states that utilizing the “same-risk-same-regulatory-outcome principle, we should start by ensuring basic protections are in place for consumers and investors.” Platforms need to step to the plate and invite more oversight too – unless you want to completely destroy crypto markets as a few bad actors can ruin it for all.
Brainard has concerns about the stablecoin market too while admitting there may be some benefits to payments but risks may rise in the currently concentrated market. She believes a CBCD may enhance stability though.
“Innovation has the potential to make financial services faster, cheaper, and more inclusive,” says Brainard, but minus regulation these benefits may be for naught.