The Financial Stability Report that was released on Thursday by the RBI stated that it is essential to arrive at a common approach to crypto assets in order to address potential risks to financial stability and safeguard investors. It stated that various international options are being considered in this context.
The inherent vulnerabilities in the crypto ecosystem have been highlighted by the collapse and bankruptcy of the crypto exchange FTX and the subsequent sell-off in the market for crypto assets.
According to the report, one option is to apply the “same-risk, same-regulatory-outcome” principle and place them under the same regulation as traditional financial intermediaries and exchanges.
It was noted that one other option is to prohibit crypto assets because their actual uses are virtually nonexistent and because different nations have distinct legal systems and individual rights in relation to state powers. It stated that the underlying instability and riskiness would ultimately prevent the sector from expanding, so the third option is to allow it to implode and render it systemically irrelevant.
According to the report, the third option is risky because the sector may become more connected to mainstream finance and divert financing away from traditional finance, which would significantly impact the real economy.
Directing new innovations and plans of action after they have developed to a foundational level is testing, it brought up. According to the report, it is essential for policymakers to design an appropriate policy approach in order to promote responsible innovation and mitigate financial stability risks in the crypto ecosystem.
In this context, under India’s G20 presidency, one of the priorities is to develop a framework for global regulation, including the possibility of prohibition, of unbacked crypto assets, stablecoins, and decentralized finance (Defi), it said.
The collapse and bankruptcy of the crypto exchange FTX and the subsequent sell-off in the crypto assets market have highlighted the inherent vulnerabilities in the crypto ecosystem.
Recently, Binance, the largest crypto exchange, also prohibited withdrawals of stablecoins on its platform. The implosion of FTX 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 has provided several insights, it said crypto assets are highly volatile.
The price of Bitcoin has tumbled by 74 percent (as on December 14, 2022) from its peak in November 2021. Other crypto assets have also experienced similar falls in prices and heightened volatility.
In addition, crypto assets exhibit high correlations with equities, it noted.
Furthermore, it said, contrary to claims that they are an alternative source of value due to inflation hedging benefits, crypto assets’ value has fallen even as inflation rose.
Second, the report said, the collapse of TerraUSD/Luna is a reminder of how so-called stablecoins that promise to maintain a stable value relative to fiat currency are subject to classic confidence runs.
Finally, it said, the failure of FTX and Celsius reveals that crypto exchanges and trading platforms were carrying out different functions such as lending, brokerage, clearing, and settlement that have different risks without appropriate governance structures.
This exposed them to credit, market, and liquidity risk disproportionate to what was necessary to discharge their essential functions, it said, adding leverage is a constant theme across the crypto ecosystem, making failures rapid and losses huge and sudden.