The Basel Committee on Banking Supervision (BCBS) issued a consultation paper on the prudential treatment of banks’ cryptoasset exposures on June 10, in a bid to provide banks with a regulatory framework to deal with the fast-developing asset class.
The move comes as policy-makers around the world take steps to control the largely unregulated market. China recently banned the mining of bitcoins — a key process that records and verifies transactions and creates new tokens — in several provinces, contributing to a 45% drop in value since mid-April.
“New technologies move fast and regulation is always playing catch-up,” says Miriam Everett, global head of data and privacy at law firm Herbert Smith Freehills.
Johann Möller, an analyst at Fitch Ratings, describes the BCBS document as “the first piece of tangible regulation providing a steer for banks globally, in what remains something of a Wild West space”.
The volatility associated with bitcoin and similar tokens, such as ethereum, has led the BCBS to call for them to carry the most stringent bank capital rules. However, the regulator was clear to draw differences between cryptocurrencies and stablecoins, which are pegged to traditional assets, such as fiat currencies.
Cryptoassets without such a stabilisation mechanism should attract a much higher risk-weight of 1250% to reflect their significantly higher risks to banks, the BCBS paper states.
“It’s a strong message to banks to telling them to avoid this type of investment,” Mr Möller says. “It’s very different to hold a cryptocurrency like bitcoin on a balance sheet because the price is so volatile.”
Stablecoins are not being stigmatised in the same way that cryptocurrencies are
While the BCBS acknowledged that banks’ exposure to cryptoassets remains small, it expressed clear concerns that the rapid growth of cryptocurrencies without the backing of a reserve asset poses material risks for banks.
“What is interesting in the Basel paper is how it segments cryptocurrencies and stablecoins. There is a very high risk-weighted percentage attached to cryptocurrencies, whereas stablecoins just require a capital add-on of some kind,” says Haydn Jones, a blockchain and crypto specialist at PwC. “Stablecoins are not being stigmatised in the same way that cryptocurrencies are.”
Risk and resilience
As the Facebook-led consortium pushes ahead with its cryptocurrency project Diem, which is set to launch as a dollar-pegged stablecoin later this year, Mr Jones believes that the regulation of stablecoins would have been at the forefront of the committee’s concerns. “We’re not far away from social media platforms being a bit like banks, which is where an interesting intersect is going to develop,” he says. “If you look at Facebook’s brand position with two billion users, then a digital token backed by a real asset that can send money instantaneously could prove very potent.”
“[The BCBS’s proposals] are about making sure digital assets develop into something which is safe for society to use,” he adds.
“If something went seriously wrong with bitcoin and ethereum, would the UK coordinate a response with the US and Europe [as seen in previous financial crises]?” Mr Jones continues. “Until [cryptoassets] can demonstrate resilience and robustness over an extended period of time, and the ability to withstand failure, then regulators have to take appropriate precautions.”
On top of volatility, the risks inherent in cryptoassets also include money laundering and terrorist financing, according to the document. Cryptocurrencies such as bitcoin are held in digital wallets, making it possible to verify activity on the blockchain — but not verify who sits behind the wallet. “The absence of transparency is as much of a concern [as volatility], contributing to the high risk-weight,” Mr Möller says.
Notable in their absence from the proposals are central bank digital currencies (CBDCs), suggesting that, if introduced, they would have similar risk profiles to cash. “It’s telling that the Basel document is completely silent on CBDCs,” Mr Möller adds.
The BCBS consultation closes on September 10.