The Proliferation of Cryptocurrencies

Tightening financial regulation and supervision, as well as the development of global standards, can help address many of the challenges associated with cryptoassets.

The world of cryptocurrencies, already characterized by high volatility, has undergone another upheaval with the collapse of one of the largest platforms, highlighting the risks associated with cryptoassets that lack basic protections.

The losses accompany an already perilous period for cryptocurrencies, whose market value has shrunk by trillions of dollars. The value of bitcoin, the largest of them, has fallen by nearly two-thirds from its peak at the end of 2021, and about three-quarters of investors have lost money on it, a new analysis by the Bank for International Settlements showed in November.

The cycle of ups and downs

During the period of stress, we saw inefficiencies in the stablecoin market, cryptocurrency-focused hedge funds and crypto exchanges, which in turn raised serious concerns about market integrity and user protection. With growing and deepening ties to the mainstream financial system, concerns about systemic risk and financial stability may also arise in the near future.

Many of these concerns can be addressed by strengthening financial regulation and supervision and by developing global standards that can be consistently applied by national regulators.

Our reports address the issues noted above at two levels. First, we take a broad approach, looking at key organizations that perform core functions in the sector, and thus our findings and recommendations are applicable to the entire cryptoasset ecosystem.

Second, we focus more narrowly on stablecoins and their mechanisms. They are cryptoassets designed to maintain a stable value relative to a particular asset or pool of assets.

Emerging issues

Cryptoassets, including stablecoins, are not yet risks to the global financial system, but they have already had a significant impact on some emerging market and developing countries. Some of these countries are experiencing large retail inventories and currency substitution through crypto-assets, mainly dollar-denominated stablecoins. Some are experiencing cryptoization where these assets substitute for local currency and assets and circumvent currency exchange restrictions and capital controls.

Such substitution can lead to capital flight, loss of monetary sovereignty, and threats to financial stability, creating new challenges for policymakers. Officials need to address the root causes of cryptoization by increasing confidence in their domestic economic policies, currencies and banking systems.

Advanced economies are also exposed to financial stability risks associated with cryptocurrencies, given that institutional investors have increased holdings of stablecoins, attracted by higher yields in a previously low interest rate environment. We therefore argue that it is important for regulators to manage cryptocurrency risks operationally while not stifling innovation.