ECB warns that unbacked crypto assets represent a risk to financial stability

The European Central Bank (ECB) stated that unbacked crypto-assets pose a risk to financial stability.

The bank said it conducted “a deep dive into crypto-asset leverage and crypto lending” and discovered evidence that these operations were becoming more dangerous, sophisticated, and intertwined with traditional institutions. This was disclosed by ECB president, Christine Lagarde, according to Financial Times.

The market is being scrutinized more closely by central banks and governments. In Nigeria, the Securities and Exchange Commission issued cryptocurrency regulations, while the Central Bank of Nigeria has had an exciting prohibition on banks facilitating transactions.

What ECB is saying

The European Central Bank said“Investors have been able to handle the €1.3tn fall in the market capitalisation of unbacked cryptoassets since November 2021 without any financial stability risks being incurred. However, at this rate, a point will be reached where unbacked cryptoassets represent a risk to financial stability.” 

The ECB is developing a digital euro and plans to test a prototype next year before choosing whether to introduce it three years later. Lagarde said its own central bank-backed digital currency would be “vastly different to many of those things”.

Links between eurozone banks and crypto-assets “have been limited so far”, the ECB said in its report on Tuesday, adding: “Market contacts indicate there was growing interest in 2021, mainly via expanded portfolios or ancillary services associated with digital assets (including custody and trading services)”.

The ECB also cited risks from decentralised finance, or DeFi, in which cryptocurrency-based software programs offer financial services without the use of intermediaries such as banks.

Crypto credit on DeFi platforms grew by a factor of 14 in 2021, while the total value locked was hovering at around €70bn until very recently, on a par with small domestic peripheral European banks,” it said.

The EU is finalising legislation, called markets in crypto assets, but the ECB said it would not come into force until 2024 at the earliest. “Given the speed of crypto developments and the increasing risks, it is important to bring cryptoassets into the regulatory perimeter and under supervision as a matter of urgency,” it said.

What you should know

  • The US Securities and Exchange Commission has warned the investing public about cryptocurrencies, stating that the digital asset class is not that decentralized. This criticism comes days after the Nigeria SEC decided to regulate digital assets.
  • The Nigerian SEC has released new rules for Digital Assets as part of its effort to regulate digital/virtual assets such as Bitcoins and NFTs.
  • The SEC’s action effectively legalizes digital assets such as cryptocurrencies and NFTs in Nigeria, where the central bank had imposed an indefinite prohibition.
  • Market participants are awaiting the apex bank’s response to the new legislation of the Nigerian SEC on digital assets.

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