RBI Proposes Common Approach to Crypto Assets to Avoid Financial Risks

To address potential risks to financial stability and protect investors, it is important to arrive at a common approach to crypto assets, according to the Financial Stability Report published by RBI on Thursday.

In this context, various options are being examined internationally, it is said said.

One option is to apply the principle of equal risk, equal regulatory outcome and subject them to the same regulations that apply to traditional financial intermediaries and exchanges, the report says.

Another possibility is the ban crypto assetssince their real-world use cases are pretty much negligible and the challenge is that different countries have different legal systems and individual rights vis-à-vis state powers, she noted.

A third option is to let it implode and make it systemically important, as underlying instability and risk-taking will ultimately stifle the sector from growth, it said.

However, the third option is fraught with risk as the sector may become more connected to mainstream finance and divert finance away from traditional finance with broader implications for the real economy, the report said.

Regulating new technologies and business models after they have grown to a systemic level is a challenge, she stressed.

In order to foster responsible innovation and mitigate financial stability risks in the crypto ecosystem, it is crucial for policymakers to develop an appropriate policy approach, according to the report.

In this regard, one of the priorities under the Indian G20 Presidency is to develop a framework for global regulation, including the possibility of banning unsecured crypto assets. stablecoins and Decentralized Finance (DeFi)it said.

The collapse and bankruptcy of the crypto exchange FTX and the subsequent sell-off in the crypto asset market have exposed the inherent vulnerabilities in the crypto ecosystem.

Lately, binance, the largest crypto exchange, also banned stablecoin withdrawals on its platform. FTX’s implosion was preceded by the failure of TerraUSD/Luna, an algorithmic stablecoin, a run on Celsius, a crypto lender, and the bankruptcy of Three Arrows Capital, a cryptocurrency hedge fund.

Given that the turmoil has provided several insights, it said that crypto assets are highly volatile.

The price of bitcoin has fallen 74 percent (on December 14, 2022) from its peak in November 2021. Other crypto assets have also seen similar price declines and increased volatility.

Additionally, crypto assets show high correlations with stocks, she noted.

Furthermore, contrary to claims that they represent an alternative source of value due to the benefits of inflation hedging, the value of crypto assets has declined even as inflation rises.

Second, according to the report, the collapse of TerraUSD/Luna is a reminder of how so-called stablecoins, which promise to maintain a stable value relative to fiat currency, are subject to classic trust runs.

Finally, the failure of FTX and Celsius shows that crypto exchanges and trading platforms perform different functions such as lending, brokerage, clearing and settlement, which carry different risks without proper governance structures.

This exposed them to credit, market and liquidity risks that were disproportionate to what was needed to perform their essential functions, it said. Adding leverage is a constant theme throughout the crypto ecosystem, making failures fast and losses huge and sudden.