FSB Highlights Concerns and Risks Involved in Crypto Markets

• 1 The Financial Stability Board (FSB) is an international organization that monitors and assesses the risks of multi-function crypto-asset intermediaries.
• 2 The concerns highlighted by FSB revolve around the various operations of crypto assets.
• 3 It is important to analyze the risk factors that support the growth of crypto markets.

Crypto assets are digital representations of value that can be stored, transferred, or traded electronically, including digital currencies and NFTs. They are part of the assets that use cryptography to protect digital data and distributed ledger technology to record transactions.

Multi-function Crypto asset intermediaries (MCIs) are individual firms, groups, or associations that offer a range of crypto-based services, products, and functions that revolve around operating the trading platform.

The primary source of revenue for MCIs is transaction fees generated from trading-related activities. The other sources include revenue from operating a blockchain infrastructure for which they can collect transaction validation fees.

Concerns related to MCIs as per FSB’s Recent Report

The FSB is an international organization that monitors and makes recommendations about the global financial system. It was established in 2009 with the backing of the G20. 

The concerns include:

Transparency

It has been observed that most MCIs are not transparent in terms of their corporate structure. They disclose information only if it is a small part of the business and not specific to a jurisdiction. It failed to provide a clear list of transaction activities or audit practices.

Anti-competitive behavior

It has a large concentration of services in one place, which leads to anti-competitive behavior that makes the system more vulnerable. This concentration makes it difficult for new players to enter the market and increases switching costs for users to a different service provider.

Crypto-Friendly Banks

The banks that were allowing transactions in cryptographic assets were shut down. It highlights the risks and vulnerabilities of having concentrated deposits tied to businesses relying on crypto assets. The stress in the crypto asset market has led to substantial losses for investors and reduced confidence in users’ minds.

Cryptocurrencies and Fiat Currencies

MCIs depend on banks and payment providers for transaction execution, including conversion between cryptocurrencies and other services.

Financial Stability Risks

Market Risk

It includes the risk of losses arising from movements in market prices due to a movement or any event in the crypto space.

These risks include price volatility, a lack of accountability and transparency. The effects of these risks are an impact on the broader crypto market, an impact on other asset classes with indirect exposure to crypto assets, and reduced confidence in the marketplace.

The recent event that has led to market impact is Bitcoin spot ETF approval.

Liquidity Risk

It is the risk of incurring losses that are a result of the inability to meet payment obligations on time when they become due or without incurring unacceptable losses.

The liquidity risks include centralization in large exchanges, reserve liquidity mismatches, susceptibility to investor runs, and scalability confusion.

The impact of these risks includes indirect exposure to crypto assets, user confidence reduction, and a decrease in the issuance of stablecoins. A recent development is the introduction of mixed-collateral stablecoins.

Credit Risk

These risks are related to the counterparties involved in the crypto asset market and directly exposed crypto assets that fail to meet their obligations per agreed terms. 

The vulnerabilities include related party transactions, financial connections with affiliated entities, a lack of sound governance, a lack of disclosure requirements, and excessive leverage.

The risk intensity increases with direct institutional or user exposure, indirect exposure to crypto assets, confidence effects, margin and leverage trading, and when used as collateral.

Operational Risks

It refers to the risk of loss resulting from inadequate or failed internal processes and systems, human errors, or external events.

The vulnerabilities include high technological dependency, the pitfalls of blockchain infrastructure, cyber security risks, and the operation of digital wallets and exchanges.

The risks are enhanced by the system’s interconnections, infrastructure, and network connections.

Capital flow risks

It refers to the potential for large and sudden changes in the flow of capital between countries due to the buying and selling of crypto assets.

The risks involved are anonymity and opacity, which is a lack of clarity on participants and activities, offshore operations, and the speed and ease of moving funds.

The risk transmitters are direct institutional or user exposure, use for cross-border payments, and use for illegal activities.

Conclusion

The FSB aims to promote enhanced cross-border cooperation and information sharing among local authorities to effectively regulate and address gaps in the operations of MCIs.

It will establish international standards for transparency and reporting to ensure a comprehensive understanding of the operations of MCIs across jurisdictions.

Regulatory measures will develop and implement clear regulatory frameworks specifically designed to cater to the unique challenges highlighted related to market integrity, investor protection, and financial stability.

FAQs

What are the motivations and objectives behind regulating crypto asset markets?

To create legal harmonization in terms of mandates, authorities’ roles, and supervision activities.

Is there any synergy and interconnection between traditional and modern financial institutions?

The central banks and financial authorities will acquire new mandates to regulate and supervise crypto asset activities.