EU watchdog does not deem crypto link to TradFi ‘significant’ to pose systemic risk yet
The European Systemic Risk Board (ESRB) said the crypto sector does not pose any systemic risks to the real economy for now as its current links to the traditional financial sector are not “significant.”
The ESRB made the statement in its latest report on the “systemic implications” of crypto and the policy options to deal with them.
‘Not yet systemic’
The ESRB report said that the entire crypto market cap is equal to a very small fraction of the traditional financial sector, and shocks in the sector are not prone to contagion outside the crypto industry.
The market cap of Italy-based UniCredit — EU’s 15th largest bank — or the market cap of a single FAANG company — Amazon — is roughly the same as that of all cryptocurrencies and stablecoins combined.
According to the ESRB:
“It [the report] concludes that the [crypto] sector is not yet systemic.”
The regulator added that the Financial Stability Board and other international regulatory bodies support its findings.
However, the watchdog also said this could quickly change considering the “exponential” growth of the crypto industry and its trademark high volatility.
Risks on the horizon
The ESRB said as the crypto sector becomes more closely “interlinked” with the traditional financial system, it will inevitably lead to more risk for the real economy.
Additionally, increased permeation of distributed ledger technology — or similar innovations — in the financial sector could also give rise to various systemic risks for financial stability.
The ESRB urged relevant regulatory authorities to stay vigilant and continue to improve their monitoring tools for the sector to ensure that any shocks in the crypto industry do not spread to the broader financial system.
According to the report, standardized reporting and disclosure requirements for financial institutions — such as banks and investment funds — that are exposed to crypto, stablecoin issuers and e-wallet service providers will help regulators monitor and identify potential contagion channels.
The ESRB also recommended placing limits on leveraged trading in the crypto sector, particularly for investment funds. The report said that leveraged trading is an area that could quickly become systemic and cause contagion if not supervised properly — especially for leverage obtained through the traditional financial system.
Additionally, the ESRB said crypto-asset lending activities — the primary area providing leverage within the crypto sector — are not covered by MiCA regulation and need a new comprehensive regulatory framework to supervise them.
According to the regulator, one way to deal with the risks is to limit crypto firms’ lending and increase the collateral requirements for DeFi products.
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