RBI Suggests Common Approach to Crypto Assets to Avoid Potential Financial Risks

To address potential financial stability risks and protect investors, it is important to achieve a common approach to crypto assets, the Financial Stability Report released by RBI said on Thursday.

In this context, various options are being considered at the international level, he said.

One option is to apply the principle of same risk, same regulatory outcome and subject them to the same regulations that apply to financial intermediaries and traditional exchanges, the report says.

Another option is to ban crypto assets, as their actual use cases are almost negligible and the challenge is that different countries have different legal systems and individual rights vis-à-vis state powers, a- he noted.

A third option is to let it implode and make it systemically irrelevant, as the underlying instability and risks will ultimately prevent the sector from growing, he said.

The third option, however, is fraught with risk as the sector could become more interconnected with traditional finance and divert funding away from traditional finance with a wider effect on the real economy, according to the report.

Regulating new technologies and new business models once they have reached a systemic level is a challenge, he stressed.

To promote responsible innovation and mitigate financial stability risks in the crypto ecosystem, the report states that it is essential that policymakers design an appropriate policy approach.

In this context, under India’s G20 Presidency, one of the priorities is to develop a global regulatory framework, including the possibility of banning, unbacked crypto assets, stablecoins and decentralized finance (DeFi), did he declare.

The collapse and bankruptcy of crypto exchange FTX and the subsequent market sell-off of crypto assets have exposed the inherent vulnerabilities in the crypto ecosystem.

Recently, Binance, the largest crypto exchange, also banned stablecoin withdrawals on its platform. The FTX implosion was preceded by 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.

Observing that the turmoil provided several insights, he said that crypto assets are highly volatile.

The price of Bitcoin has fallen 74% (same as December 14, 2022) since its November 2021 peak. Other crypto assets have also seen similar price declines and increased volatility.

Furthermore, crypto assets exhibit high correlations with stocks, he noted.

Also, contrary to claims that they are an alternative source of value due to the benefits of inflation hedging, the value of crypto assets has fallen even as inflation has risen.

Second, according to the report, the TerraUSD/Luna collapse is a reminder of how so-called stablecoins that promise to maintain stable value against fiat currency are subject to classic confidence cycles.

Finally, he said, the failure of FTX and Celsius reveals that crypto exchanges and trading platforms performed different functions such as lending, brokerage, clearing and settlement which pose different risks without appropriate governance structures.

This exposed them to credit, market and liquidity risk disproportionate to what was needed to perform their core functions, he said, adding that leverage is a constant theme. in the crypto ecosystem, making failures fast and losses huge and sudden.

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