The recent collapse of crypto exchange FTX and the ensuing sell-off in crypto markets have put the spotlight on vulnerabilities in the crypto ecosystem, according to the Economic Survey 2022-23 presented in Parliament on Tuesday.
crypto Assets are self-referential instruments and do not rigorously pass the test of being a financial asset as they have no intrinsic cash flows.
US regulators have disqualified Bitcoin, ether and various crypto assets other than securities.
A rare joint statement by the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) on Jan. 3, 2023, emphasized their concerns about the risks posed by crypto assets to the banking system, they noted .
The geographically ubiquitous nature of the crypto ecosystem requires a common approach to regulating these volatile instruments, and the global response to cryptos is evolving, it said.
Noting that crypto assets are new forms of digital assets implemented using cryptographic techniques, the survey said its market has been highly volatile, with its overall valuation of nearly $3 trillion (nearly $2,45,35, Rs 9 billion) in November 2021 to less than US$1 trillion (nearly Rs 81,78,500 crore) in January 2023.
The volatility of the crypto-asset ecosystem has brought to the fore its fragile backing and governance issues, as well as increasing complexity and opacity, it said.
With the associated rising risks to financial stability, the issue of regulation of crypto assets has recently moved up the political agenda of many nations. International forums such as the OECD and the G20 are discussing a globally coordinated approach to regulating crypto assets, she noted.
monitoring and regulation cryptocurrencies have been difficult, and regulators around the world are finding it difficult to keep on top of the new and emerging issues in the fast-moving, unexplored space, it said.
While crypto assets appear to have been designed to disintermediate traditional financial services, this has created new unregulated intermediaries, it said, adding that the promise of decentralization has yet to be implemented in practice.
New centralized intermediaries such as crypto asset exchanges, wallet providers and crypto conglomerates require users to trust centralized entities, it said.
The increasing importance of these entities could force regulators to consider them systemic financial market infrastructures (FMIs), she said, adding that the fact that they are still largely unregulated is a concern around the world.
Interestingly, crypto asset holdings have been primarily concentrated in the hands of a few “whales.”
It is estimated that around 85 percent of all bitcoin in circulation is held by 4.5 percent of companies, and the underlying protocols used to create crypto assets may also conflict with other policy goals, such as massive energy intensity of crypto assets mining.
There are minimum global standards for unsecured crypto assets, which currently do not mitigate all risks and vulnerabilities, it said.
“While Standard-Setting Bodies (SSBs) have made efforts to adapt and develop standards, these continue to focus primarily on specific topics (financial integrity), sectors (payments, securities and banking), products (global stablecoins) or designated entities from the domestic ones Authorities classified as systemic,” it said.
Therefore, there are regulatory loopholes at every stage when non-bank crypto assets are issued, transferred, exchanged or stored. The cross-sector and cross-border nature of crypto limits the effectiveness of uncoordinated national approaches, it said.
The terminology used to describe the various activities, products and stakeholders is not harmonized worldwide. The term “crypto asset” itself refers to a wide range of digital products that, due to their actual or intended use, may require the attention of several national regulators.
