Crypto could lead to a 2008 meltdown, a Bank of England official warns

A passageway near the Bank of England (BOE) in the City of London, UK, on ​​Thursday 18th March 2021.

Hollie Adams | Bloomberg | Getty Images

Bank of England Deputy Governor for Financial Stability Jon Cunliffe has warned that cryptocurrencies could spark a global financial crisis if tough regulations are not put in place.

In a speech on Wednesday, Cunliffe compared the growth rate of the crypto asset market from $ 16 billion five years ago to $ 2.3 trillion today to the subprime mortgage market of $ 1.2 trillion in 2008.

“When something in the financial system is growing very quickly and growing in a largely unregulated area, the financial stability authorities have to sit up and take notice,” he said.

Cunliffe acknowledged that governments and regulators need to be careful not to overreact or classify new approaches as “dangerous” just because they are different, and noted that crypto technologies offer the prospect of “radical improvements” in financial services.

However, he claimed that the current uses of crypto assets, while the risks to financial stability remain limited for the time being, pose a financial stability problem as the majority “have no intrinsic value and are prone to major price corrections”.

Bitcoin and Ethereum, the two largest cryptocurrencies, fell more than 30% earlier this year before recovering and have proven to be extremely volatile since their inception. Prices are prone to a variety of external triggers, from comments from Tesla CEO Elon Musk to regulatory crackdowns by the Chinese government.

“The crypto world is beginning to connect to the traditional financial system and we are seeing the emergence of leveraged actors. And most of all, this happens in a largely unregulated space, ”said Cunliffe.

His comments echo those of Bank of England Governor Andrew Bailey, who warned in May that cryptocurrency investors should be willing to lose all of their money as assets lack “intrinsic value”.

The UK’s Financial Conduct Authority has also warned of the risky nature of crypto investments.

Cunliffe said that if the market continues to expand at such a rate, the risk to financial stability could increase rapidly, but the extent of those risks will be determined by the speed of response from regulators and governments.

Bitcoin’s price has fallen nearly 30 times in a single day in the past five years, he said the biggest drop was a nearly 40% drop following a cyber incident involving Bitcoin and cryptocurrency exchanges in the Seychelles BitMEX.

“The forward-looking question is what could result from such events if these crypto assets continue to grow at scale, if they are further integrated into the traditional financial sector, and if investment strategies continue to become more complex?” said Cunliffe.

Crucial to whether larger price corrections can be absorbed by the system, which burdens some investors with painful losses but avoids a consequential impact on the real economy, depends primarily on the interconnectedness and the leverage effect, argued Cunliffe.

Both were present in the subprime mortgage market prior to 2008, which enabled the knock-on effects that ultimately brought the global economy to its knees, and both are becoming increasingly important in the crypto space, Cunliffe suggested. He said it is up to the authorities to manage this increasing risk and make sure the system is resilient to major corrections.

“While crypto funding works in novel ways, well-designed standards and regulations could and should enable risk management in the crypto world as it is managed in the world of traditional finance,” said Cunliffe.

Many regulators around the world have begun creating a public policy framework through which to steer the exponential growth of crypto assets, but Cunliffe said this needed urgent attention.

“Technology and innovation have driven the betterment of finance throughout history. Crypto offers great opportunities. As [Ralph Waldo] Emerson said, ‘If you build a better mousetrap, the world will strike a path at your door,’ “he said.

“But it has to be a really better mousetrap and not one that just works by lower standards – or by no standards at all.”

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