US eyes crypto, climate among potential risks to financial stability

Top U.S. financial regulators say cryptocurrency and climate change are among the biggest risks to financial stability, as digital assets have exploded in growth to a sector worth nearly $2.3 trillion.

In a report issued on Friday, The Financial Stability Oversight Council – a regulatory group created after the financial crisis to monitor risks financial firms pose to the overall economy and financial system — noted that rapid growth of digital currencies – including stablecoins, and crypto lending and borrowing – is an “important potential emerging vulnerability.”

Chaired by Treasury Secretary Janet Yellen and composed of the heads of the top financial regulatory agencies, the FSOC includes the Federal Reserve and the Securities and Exchange Commission.

Regulators highlight that markets are frothy in general and crypto prices are highly volatile – and that speculation is driving the majority of market moves. They warn that it’s unclear how much is tied directly to the economy, but added that even as the sector grows in popularity among small buyers, it “may not be appropriate for many investors.”

Officials also caution in general about the possibility of operational failures, fraud and market manipulation in crypto, where scams have proliferated recently. They emphasize risks with direct or indirect connections with banking services, financial markets and financial intermediaries, and cautioned about money laundering, tax evasion and use of cryptocurrencies in ransomware attacks.

Specifically, the report zeroed in on stablecoins — an asset class designed to smooth out digital coin volatility that’s now worth nearly $166 billion itself – and the potential for a run on stablecoins. Strained market conditions could amplify a shock to the economy and the financial system, regulators say.

The stablecoin worry

Stablecoins are digital currencies with values tied to fiat currencies like the U.S. dollar, or short-term securities, and are used by traders to get in and out of trades. They are central to many crypto activities, and increasingly are being used for lending or borrowing in other digital assets on cryptocurrency exchanges.

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Regulators worry about runs on the digital coins, and their use in payment systems, which may face some of the same basic risks as traditional payment systems that impact credit, liquidity, governance and settlement.

The agency said it’s prepared to consider steps available to it to address risks of stablecoins if Congress doesn’t enact legislation. But senior Treasury officials say that there is no specific time horizon, deadline or threshold at this time for determining whether to designate stablecoins as systemically risky.

Officials are hoping Congress enacts legislation, even as they continue to assess and monitor risks. They recommend at this time state and federal regulators use the tools and authorities they currently have to regulate stablecoins and crypto generally.

The FSOC’s assessment comes after the President’s Working Group on Financial Markets (PWG) – composed of mostly the same members of financial regulatory agencies as FSOC, detailing the risks of stablecoins. 

Officials have recommended that only banks be allowed to issue stablecoins, while asking Congress to come up with a new regulatory framework to oversee the asset class. A range of regulatory agencies including the SEC, Fed, CFTC and FDIC, are currently assessing their tools and authorities to regulate crypto.

Regulators have sketched out a to-do list for 2022 they’re calling the “crypto sprint,” which will focus on oversight of how banks could store crypto assets safely, handle exchanging fiat currency for crypto, and processing trades, among other things.

On Capitol Hill, top legislators are busy playing catch up with the booming sector. Senate Banking Committee Chairman Sherrod Brown his committee is looking seriously at new rules for stablecoins in the New Year, but hasn’t settled on specifics yet. At the same time, Senator Pat Toomey, the committee’s top Republican, just rolled out a set of guiding principles for regulating stablecoins.

This is also the first report from FSOC to highlight the risk of climate change to financial stability. Officials recommend taking “prompt action” to improve data and measurement tools to assess climate risks to the financial system, and advise regulators to promote consistent disclosures that allow investors to take climate into account for investment and lending decisions.

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