In Part 1 of this topic, I highlighted recommendations that have been made by standard setting bodies (SSBs) in relation to the regulation of the crypto asset ecosystem; and commented on the likely impact for those in the crypto space by identifying requirements that may be imposed by regulators[i].
In this Part 2, I continue the discussion by summarizing recommendations of the Financial Stability Board (FSB) and the International Monetary Fund (IMF). I note some of the key concerns raised by the private sector regarding the regulation of the crypto asset ecosystem, and conclude with some final thoughts on the development of an appropriate crypto asset regulatory regime, based on matters considered herein.
Financial Stability Board (FSB)
The FSB is an international body that monitors and makes recommendations about the global financial system. In its most recent consultative documents[ii], it proposes a broad framework for the international regulation of crypto asset activities and global stablecoin arrangements. A key objective being, to promote a consistent and comprehensive approach that can be adopted by jurisdictions. The FSB expects to provide its finalised recommendations by July 2023.
The FSB makes several key observations about the crypto asset market in providing its high-level recommendations. Some of these include:
1. That the crypto-asset market is highly interconnected. Failure or stress therein could therefore lead to rapid contagion among market participants, particularly given the volatile nature of crypto assets.
2. While direct connections between crypto-assets and traditional SIFIs are presently limited, there is potential that increased interconnectedness with the crypto asset sector’s vulnerabilities and volatility could lead to negative consequences in the broader financial system. Traditional financial entities have been participating in activities linked to the crypto asset sector by among other things, offering crypto-asset collateralized lending, facilitating payment and deposit services to crypto asset service providers; as well as supporting the capitalization of crypto projects.
3. Stablecoins serve as collateral in crypto-asset transactions and are used for the conduct of several activities including, purchasing, settling, trading, lending and borrowing of other crypto-assets.
4. Global stablecoins may be identified by three characteristics. Namely, (i) a stabilisation mechanism, (ii) their usability for payments and/or as a store of value, and (iii) their reach and adoption across multiple jurisdictions (including potential reach)[iii].
5. Since stablecoins engage in maturity transformation[iv], in a similar manner to banks and other financial institutions, they are susceptible to loss of confidence and the risk of runs on either the issuer or the reserve assets[v].
6. Stablecoin arrangements managed by decentralised mechanisms, and in particular its governance, is not always truly distributed since there are instances when governance is concentrated in a small group of developers, investors[vi] and/or large governance token holders.
The focus of the FSB’s recommendations is the management of financial stability risks and therefore does not comprehensively address other risks[vii]. Below are key recommendations relevant to crypto asset services and global stablecoin (GSC) arrangements.
Regulatory powers and tools for authorities and conformance (of crypto actors) before commencement of operations: The FSB highlights the need for appropriate regulatory powers and tools. In this regard, it recommends that jurisdictions should ensure that authorities are adequately empowered (through powers, tools and resources) to be able to effectively regulate[viii] and supervise crypto asset activities (including crypto asset issuers and service providers); as well as GSC arrangements (its associated functions and activities)[ix]. Moreover, it recommends that crypto asset actors (i.e. crypto-asset issuers and service providers, as well as all GSC arrangements) ought to meet the applicable regulatory, supervisory and oversight requirements before commencing any operations within a particular jurisdiction.
Comprehensive and proportionate oversight: Regulation, supervision, and oversight of crypto asset activities and GSC arrangements should focus on functions or activities performed and be proportionate to the risks posed (potential or actual)[x]. The foundational principle, considered here is ‘same activity, same risk, same regulation’. In other words, crypto-asset activities should be subject to regulation that is equivalent to similar functions in the traditional financial sector.
Cross-border cooperation, coordination and information sharing[xi]: Effective communication and information sharing among regulators, and other relevant authorities (on a domestic and international level), will among other things, support an approach of consistency in respect of regulatory and supervisory outcomes across sectors and borders.
Governance: The FSB recommends that a governance framework should be proportionate to the size, risks (including financial stability risk), complexity and systemic importance of a crypto asset service provider or issuer and should entail transparency as to responsibilities, obligations and accountabilities for all functions and activities. In the case of a GSC arrangement[xii], issuances should be governed and operated by an identifiable and responsible legal entity or individuals and the governance structure should allow for timely human intervention. The FSB encourages authorities to require effective compliance, notwithstanding that there may be structures or systems, like the use of DeFi protocols[xiii], used to conduct crypto-asset activities[xiv].
Risk Management: Crypto asset service providers and issuers, as well as participants in GSC arrangements, should be required to address all material risks associated with their activities. For crypto asset issuers and service providers, the importance of addressing risks arising from leverage and credit, liquidity, compliance, and maturity transformation are highlighted. It is noted that these should be considered for both normal times as well as periods of stress; and that risk profiles for different crypto-asset issuers and service providers ought to be understood as part of ensuring that an adequate risk management framework is in place. For GSC arrangements, the FSB stresses the need for risk management frameworks that address, inter alia, operational resilience, cyber security safeguards as well as AML/CFT measures and points out the importance of having policies in place to address the risks posed by all functions and activities in the arrangement. The conduct of periodical and continuous risks assessment, contingency preparedness and continuity planning are also recommended.
Data Storage: Another key recommendation of the FSB is the need for robust systems for collecting, storing and safeguarding data. There ought to be adequate controls in place to safeguard the integrity and security of pertinent data (both on chain and off chain) and same should conform to appropriate data retention and privacy regulations, etc.
Disclosures: Crypto-asset issuers and service providers, and GSC issuers ought to disclose clear and transparent information regarding their operations (functions and activities). Moreover, disclosure should include inter alia, their risk profiles, financial conditions, risk features of any products and services offered, systems and procedures in place to mitigate risks, any conflict of interests, material risks with underlying technology etc. GSC issuers should also, in ensuring transparency as to the functioning of their arrangement, provide adequate information on redemption rights and their stabilisation mechanism.
Monitoring of interconnections within the crypto-asset ecosystem and with the wider financial system: This recommendation is applicable to crypto asset activities and markets (not GSC arrangements). The FSB recommends that all relevant interconnections within the crypto asset ecosystem as well as between the crypto ecosystem and the wider financial system, be identified and closely monitored, in order to address potential financial stability risks. In this regard, interlinkages and interdependencies should be assessed on an ongoing basis. Consideration should be given to the scale of crypto asset activities and their potential to transmit contagion to the wider financial system.
Comprehensive regulation of crypto-asset service providers with multiple functions: This recommendation focuses on crypto asset service providers that offer multiple functions[xv] and activities such as custody, trading, settlement, lending/borrowing. The key concern to be addressed is ensuring that risks emanating from the offer of multiple functions, are covered by comprehensive regulation, supervision and oversight. This may involve addressing risks arising from each individual function, as well as risks arising due the combination of the functions.
Recovery and Resolution plans: This recommendation is addressed in the Global Stablecoin Report for GSC arrangements. In essence, the FSB recommends that GSC arrangements ought to have in place adequate plans to facilitate an orderly resolution, including continuity or recovery of any critical functions and activities within the GSC arrangement.
Redemption rights, stabilisation, and prudential requirements: Another recommendation raised in the Global Stablecoin Report for GSC arrangements, is the need for timely redemption for all users and effective stabilisation mechanisms. The FSB therefore suggests that GSC arrangements ought to be required to, inter alia, have in place adequate and reliable reserve assets[xvi] (which ought to comprise of only conservative, high quality and highly liquid assets), an effective stabilisation mechanism (which does not derive its value from algorithms) and meet all prudential requirements.
In summary, the FSB’s draft recommendations promote the importance of having the right powers, tools and resources for the implementation of an appropriate regulatory regime. It emphasizes the need for requirements that addresses, inter alia, governance, risk management, data storage, disclosure and transparency. Moreover, the close monitoring of the growing interconnectedness between the crypto asset ecosystem and the financial system is suggested in order to be adequately prepared in mitigating risks arising therefrom. Special considerations have been proposed for GSC arrangements including focusing on adequate stabilization mechanisms, effective redemption rights for users, as well as suitable recovery and resolution plans. Given the borderless nature of the crypto asset ecosystem, a global approach that facilitates co-operation and coordination among various jurisdictions is critical. These recommendations are intended to provide an overarching framework treating with financial stability risks. This complements the recommendations addressing more specific activities and risks, issued by various SSBs.
The International Monetary Fund (IMF)
The IMF has made public, a series of fintech notes and other policy documents, providing guidance (to its members) on important issues relative to the regulation of crypto assets. These include general advice on the regulation of crypto assets[xvii], virtual assets and anti-money laundering regulations[xviii], further guidance on the regulation of unbacked crypto assets[xix] and stablecoins[xx]; as well as its most recent policy paper on elements for an effective response to crypto assets[xxi] (for policymakers).
The IMF’s guidance, is meant to be used in accompaniment with the recommendations provided by other international agencies (such as SSBs and the FSB) towards achieving a comprehensive, consistent, and coordinated framework for the crypto asset ecosystem.
Not only does the IMF’s guidance consider matters such as market integrity, financial stability and consumer protection but also addresses potential macroeconomic risks (particularly in its most recent policy paper).
The key messages emanating from these notes in respect of the regulation of the crypto ecosystem include:
1. There is need for legal certainty on crypto assets within both private and public law. Legal certainty builds confidence and lends credence to the provision of financial products and services and is a foundational necessity for a strong financial system. Legal certainty should pertain to, among other things, the classification of crypto assets[xxii], the rights of holders and the legal powers of appropriate authorities regarding the regulation of crypto asset activities.
2. There should be effective regulation and supervision of crypto asset activities. Effective regulation will promote ‘long-term economic stability’ mitigating, inter alia, financial stability risks.
3. Criteria for licensing or registration should be clearly articulated and there should be a designated authority/authorities to carry out this responsibility, among other things.
4. Regulation should be focused on critical aspects of the crypto ecosystem such as, crypto asset service providers[xxiii], stablecoin issuers[xxiv] and arrangements[xxv], entities that carry out several functions within the ecosystem[xxvi], financial institutions exposed to or engaged with crypto assets and/or crypto related services[xxvii]. There should be appropriate prudential, conduct and oversight requirements for effective management of risks relative to financial stability, market integrity and consumer protection.
5. There should be collaboration among regulators, domestic and cross-border, to ensure effective supervision and enforcement of crypto asset regulations.
6. Continuous monitoring of the crypto asset ecosystem is necessary to be able to respond to developing risks including risks to financial stability.
7. There is a need for global consistent, comprehensive regulatory responses to the development of the crypto asset ecosystem, given the cross-sector and cross-border nature of crypto assets, and to prevent regulatory arbitrage.
8. Monetary sovereignty and stability should be safeguarded by ensuring effective monetary policy frameworks and avoiding the use of crypto assets as official currency. Moreover, measures should be put in place to guard against excessive capital flow volatility that may result due to rising crypto asset adoption.
9. Effective analysis and disclosure of fiscal risks, emanating from the adoption of crypto assets, is necessary to ensure fiscal credibility.
10. Tax treatment of crypto assets should be unambiguous.
The IMF’s guidance consists of similar themes to the FSB in relation to, inter alia, effective regulation and supervision of crypto asset activities (prudential, conduct and oversight requirements), collaboration among regulators (domestic and cross-border) and continuous monitoring of the crypto asset ecosystem. It addresses not only financial stability issues but also other risks such as market integrity, consumer protection and macroeconomic risks.
Both the FSB and the IMF have proposed recommendations for managing the broader implications of continued crypto asset adoption and the growing interconnections within the financial system. This, together with the recommendations from SSBs, can support the objective of achieving an appropriate and effective regulatory regime for the crypto asset ecosystem.
What does this mean for persons operating in the crypto asset space?
If the above recommendations are adopted by various jurisdictions, domestic legislation will empower authorities to among other things, license and supervise, conduct inspections and examinations, impose certain conditions for operating (where necessary), and take appropriate corrective and enforcement actions in situations of non-compliance (from warning letters to restrictions, imposition of administrative fines, revocation of a licence/registration, etc).
Regulation will target the management of, inter alia, operational, financial, market integrity, consumer and investor protection and reputational risks. Regulatory requirements will address matters such as disclosure (including in relation to an entity’s operations, transactions, risks of products/services offered, management and mitigation of risks), governance (accountabilities and responsibilities), conflict of interests, settlement finality, and data management and security.
For risk management, authorities will focus on whether there are suitable and commensurate resources and control functions that facilitate the identification, measurement, evaluation, monitoring, reporting, and control of all material risks; including the adequacy of contingency arrangements and business continuity planning.
For stablecoin arrangements there may likely be strict requirements of reserve assets that are of sufficient credit quality, highly liquid (and therefore immediately convertible to fiat currency) and unencumbered. Capital buffers are also likely to be required to ensure maintenance of stability at all times. The submission of reports detailing the size and nature of activities being conducted by an entity will also be an important aspect imposed by regulators.
Cooperation arrangements among authorities will be a critical element in the regulation and supervision of crypto asset activities and may be underpinned by bilateral and/or multilateral MoUs, supervisory colleges and other fora to keep communication lines open.
Private sector views on the regulation and supervision of the crypto asset ecosystem.
A discussion on an appropriate regulatory regime for the crypto asset ecosystem would be incomplete without considering the views of those who will be required to comply with regulatory requirements.
The private sector has highlighted some key concerns that should be considered in the development of a regulatory regime[xxviii]. Some of the matters raised share common ground with the recommendations provided by international agencies (e.g. the need for legal certainty and regulatory clarity). However, there are divergent views on other matters (such as the approach to stablecoins and the regulation of DeFi).
Some of the shared concerns include, the need for proper taxonomy for crypto asset activities and legal certainty on the regulatory perimeter and associated requirements. It is agreed that there ought to be a global coordinated approach which, among other things, would facilitate greater regulatory clarity.
There is, however, a departure in views (in varying levels) on other matters. For example, while there is agreement that the principle ‘same activity, same risk, same regulation’ may be applicable to crypto asset activities in some instances, it may not be appropriately applicable in all instances (given the various characteristics and functions of crypto assets)[xxix]. In that regard, caution should be adopted in implementing this principle and consideration should be given to variations of this approach[xxx] “to reflect the diversification of the sector and the different business models that have been emerging[xxxi]” as well as the unique risks posed by crypto assets. In other words, regulation should recognise the nuances within the crypto assets space including, “design choices, governance mechanisms and economic incentive structures”[xxxii].
Another area where there are divergent views is the regulation of DeFi. Key points emphasised by the sector include that:
(a) The nature of DeFi warrants careful consideration before implementing regulations since the services offered within the ecosystem does not rely on intermediating financial institutions. Therefore, a traditional regulatory approach would be impractical to transpose onto, or account for the features of, the DeFi ecosystem[xxxiii]. One suggestion provided is that regulation should include a focus on “centralised business owned applications, or onboarding access points to protocols”[xxxiv].
(b) There is also a strong argument that DeFi developers generally ought not be identified by authorities as crypto market intermediaries or participants, as their only role is to develop and publish code. The key consideration should be whether they directly facilitate financial transactions for customers or hold their assets[xxxv].
(c) It is important to distinguish between systems that are decentralised in name only, and controlled for example by ten to twenty persons versus true decentralisation of hundreds/thousands of persons[xxxvi]. One suggestion for evaluating decentralisation could include applying a multi-pronged test (that looks at the role of the developers, whether contributors to the operation of the protocol comprise of a selected few versus a high number of unaffiliated persons, and who holds assets for users) [xxxvii].
An additional matter of contention is in relation to the regulation of stablecoins. For example, the FSB speaks to the need for reliable and adequate reserve requirements for stablecoins, and notes that reserve assets should consist of only highly liquid and conservative assets.
A key concern regarding this recommendation is the lack of recognition and distinction as to various types of stablecoins in determining applicable regulatory requirements. It is unlikely that all stablecoins will be backed only by fiat, and other traditional financial instruments (i.e., ‘conservative assets’). There are in fact stablecoins that are backed by other crypto assets, or collateralized by way of algorithms and/or a combination of any of the above. Distinctions as to types of stablecoins would assist in addressing the variations in risks such as credit, counterparty and liquidity, depending on the stabilisation mechanism used.
Furthermore, regulation that focuses on reserves that consists of only ‘conservative assets’, and therefore ignore those that are derived by algorithms or those supported by unbacked crypto assets, would likely result in negative consequences for the continued evolution of the blockchain ecosystem. In that regard, it is proposed that the focus should be on ensuring there is adequate collateralization and effective risk management strategies, regardless of the way a stablecoin is supported. The Crypto Council for Innovation for example, proposes that in relation to algorithmic stablecoins, regulators ought to consider “enacting narrowly tailored collateralization requirements that allow for the development of safe software code”. After all, excluding these types of stablecoins from the regulatory perimeter could have the negative consequence of facilitating regulatory arbitrage and/or the conduct of harmful unregulated practices given that, it would be almost impossible to remove these types of stablecoins entirely from its respective market, putting users at an even greater risk of harm.
Overall, the key theme emanating from the private sector is that a regulatory regime for the crypto asset ecosystem must be fit for purpose. It ought not to be disproportionately and overly prescriptive, consequently hindering innovation and advances that could lead to financial efficiency, inclusion, and overall development of the financial system. Equally, a regulatory regime that fails to account for key risks, that may be unique to this ecosystem, could ultimately jeopardize financial stability, among other things.
Conclusion
In Parts 1 and 2 of this topic, key recommendations made by international agencies were highlighted. It was noted that in order to achieve an appropriate framework for the regulation of the crypto asset ecosystem ‘fit for purpose’, authorities will need to consider the manner in which specific risks can be addressed together with broader implications for the financial system. Consideration ought to be given to the recommendations of the various SSBs and other international agencies, as they contain critical elements for the creation of an adequate and comprehensive regulatory framework.
Notably, a global approach appears to be the only effective manner to regulate this ecosystem, given its very nature. Diversification in fundamental areas, in various jurisdictions, would give way to issues such as regulatory arbitrage and undermine the ability to truly mitigate and/or manage risks (both actual and potential); consequently resulting in negative repercussions for the financial sector. It is therefore important for jurisdictions to ensure that in adopting the various recommendations, offered by international agencies, critical elements are implemented in a similar manner or have a similar effect.
Among other things, regulation is necessary to prevent excessive risk taking in this nascent sector as well as to reduce the growing potential for risk transmission, whether within the crypto asset ecosystem or to the wider financial system. It is meant to provide guardrails that facilitate, inter alia, enhanced market transparency and accountability, market integrity, adequate consumer/investor protections, financial stability and AML/CFT defences.
Some of the key elements to be covered by a regulatory regime for the crypto asset ecosystem include, legal certainty, regulatory clarity, adequate tools, powers and resources of authorities, appropriate risk management strategies, adequate governance and cross border co-operation.
It has also been suggested that the unique features of crypto assets and the way the ecosystem operates, be taken into account and there is merit in considering same. While there are many aspects of the crypto asset ecosystem that may be similar to activities conducted in the traditional financial sector, there are also varying models that may present unique risks that ought not to be ignored.
Regulation is critical for the protection of the financial system and its participants, but it ought not to hinder the evolution of innovation and the development of a nascent sector that may provide solutions for varying matters; including efficiency and financial inclusion.
Furthermore, flexibility and openness to the possibility that proven tools for the traditional financial sector may need to be adjusted to account for unique (potential and growing) risks emanating from the crypto asset sector, should be built into an appropriate regime. Implementing, an appropriate global, coordinated and consistent regulatory approach will take time and will require efforts from authorities as well as the private sector.
References and Notes
[i] Provided, these recommendations are adopted.
[ii] International Regulation of Crypto-asset Activities: A proposed framework – questions for consultation(Crypto-Asset Ecosystem Report, October 2022) https://www.fsb.org/2022/10/international-regulation-of-crypto-asset-activities-a-proposed-framework-questions-for-consultation/ and Review of the FSB High-level Recommendations of the Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements: Consultative Report (Global Stablecoin Report, October 2022) https://www.fsb.org/2022/10/review-of-the-fsb-high-level-recommendations-of-the-regulation-supervision-and-oversight-of-global-stablecoin-arrangements-consultative-report/ .
[iii] First noted in its 2020 Report, “Regulation, Supervision and Oversight of ‘Global Stablecoin’ Arrangements”: https://www.fsb.org/2020/10/regulation-supervision-and-oversight-of-global-stablecoin-arrangements/
[iv] “The perception that SCs (stablecoins) can be redeemed on demand is enough for them to create vulnerabilities from liquidity and maturity transformation, as SC reserve assets could be illiquid or have longer maturities”: per the Federal Reserve Bank Report: “The Financial Stability Implications of Digital Assets” (September 2022).
[v] See Pg 18 Global Stablecoin Report, October 2022.
[vi] See Pg 7 International Regulation of Crypto-asset Activities: A proposed framework – questions for consultation (Crypto-Asset Ecosystem Report, October 2022).
[vii] Such other risks may include AML/CFT; data privacy; cyber security; consumer and investor protection; market integrity; taxation; monetary policy; monetary sovereignty and other macroeconomic concerns, etc. See page 33 of Crypto-Asset Ecosystem Report, October 2022.
[viii] A key recommended regulatory requirement is that crypto-asset issuers and service providers should meet all applicable requirements before commencing any operations in the relevant jurisdiction.
[ix] An authority’s powers in relation to GSC arrangements should be commensurate with their existing or potential size, complexity, risk and/or extent of use as a means of payment and/or store of value and should extend to entities and persons that are engaged in GSC activities.
[x] This is determined having regard to size, complexity and systemic importance, among other things.
[xi] Among authorities, cross-border cooperation and information sharing should aim to facilitate a shared understanding of the risks and activities of crypto-assets, issuers and service providers in normal times and in times of stress. For GSC arrangements, authorities should take into account the complexity and the potential evolution of the GSC arrangement and the risks it poses over time. (See Global Stablecoin Report, October 2022 and Crypto-Asset Ecosystem Report, October 2022).
[xii] The FSB also suggests that governance framework for GSC’s should ensure effective disclosure to users, investors, and other stakeholders, including how governance and accountability is allocated and how potential conflicts of interest are addressed, as well as clarify the limits of accountability and legal liability, where applicable.
[xiii] The FSB asserts that regulators/supervisors need to “look past the labels and marketing around a product or service, and … establish ways to identify who exercises effective control on the protocol or provides access to the protocol, and to make them accountable under existing or future regulation”.
[xiv] See concerns below raised by the private sector on this matter.
[xv] For example, crypto-asset trading platforms, that offer various services, including facilitating transactions, settlement and clearing, non-custodial and custodial wallet provisioning, (including the sale of software and hardware for non-custodial wallet), market-making, offering investment vehicles, lending and borrowing, proprietary trading and issuance, among others. (See pg. 28 Global Stablecoin Report, October 2022 and Crypto-Asset Ecosystem Report, October 2022).
[xvi] Per Global Stablecoin Report, October 2022 and Crypto-Asset Ecosystem Report, October 2022: “The market value of reserve assets should meet or exceed the amount of outstanding claims or stablecoins in circulation at all times”.
[xvii] Cuervo, Cristina; Morozova, Anastassiya; and Sugimoto, Nobuyasu. 2020. Regulation of Crypto Assets. Regulation of Crypto Assets (imf.org)
[xviii] Schwarz, Nadine; Poh, Kristel; Chen, Ke ; Jackson, Grace ; Kao, Kathleen ; Fernando, Francisca ; Markevych, Maksym. 2021b. “Virtual Assets and Anti–Money Laundering and Combating the Financing of Terrorism (2). Effective Anti–Money Laundering and Combating the Financing of Terrorism Regulatory and Supervisory Framework—Some Legal and Practical Considerations. IMF Fintech Notes 2021/003. Virtual Assets and Anti-Money Laundering and Combating the Financing of Terrorism (2): Effective Anti-Money Laundering and Combating the Financing of Terrorism Regulatory and Supervisory Framework—Some Legal and Practical Considerations (imf.org).
[xix] Bains, Parma, Arif Ismail, Fabiana Melo, and Nobuyasa Sugimoto. 2022. “Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets.” IMF Fintech Note 2022/007, International Monetary Fund, Washington, DC.
[xx] Bains, Parma, Arif Ismail, Fabiana Melo, and Nobuyasa Sugimoto. 2022. “Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements.” IMF Fintech Note 2022/008, International Monetary Fund, Washington, DC.
[xxi] 2023 IMF Policy Paper Elements of Effective Policies For Crypto Assets: https://www.imf.org/en/Publications/Policy-Papers/Issues/2023/02/23/Elements-of-Effective-Policies-for-Crypto-Assets.
[xxii] According to the IMF’s policy paper on Elements of Effective Policies for Crypto Assets, legal classification is essential for the determination of (i) an appropriate prudential and resolution regime, including the competent authority as well as potential for eligibility to access financial safety net components; (ii) relevant market conduct rules; and (iii) the applicability of the legal regime governing financial market infrastructures.
[xxiii] These include entities that provide crypto related storage, transfer, exchange, and custody of reserves services, among other things.
[xxiv] Risks associated with issuances can include liquidity mismatch, ineffective governance, lack of consumer/investor protection, ineffective cybersecurity, inadequate data protection and concentration of economic power to key service providers. (See Bains, et al: “Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements.” IMF Fintech Note 2022/008, International Monetary Fund, Washington, DC).
[xxv] There are various functions involved in stablecoin arrangements, including reserves management, network administration and governance, custody, and exchange services, etc. These functions if unregulated can pose risks to consumer protection, financial stability, market and financial integrity, and operational and cyber resilience. In that regard, consideration should be given to the implementation of enhanced disclosure requirements, independent audit of reserves, fit and proper rules for network administrators and issuers, and rules around enhanced operational and cyber resilience (IMF GFSR 2021, chapter 2).
[xxvi] Reference has been made to the FTX scenario and the fact that it offered exchange, custody, and market making services within its group, resulting in significant risks to the customers.
[xxvii] The IMF notes that “the exposure of the financial sector to crypto assets and the relative size and growth of the crypto-asset market can raise prudential and financial stability risks that should be considered.” See Cuervo, Cristina et al 2020. Regulation of Crypto Assets (imf.org).
[xxviii] Based on a review of multiple submissions to the FSB in response to its recommendations. All responses can be found on the FSB’s website: https://www.fsb.org/2023/01/public-responses-to-fsbs-proposed-framework-for-international-regulation-of-crypto-asset-activities/
[xxix] See for example the submissions of Coinbase, DCGG, Alternative Investment Management Association, Chamber of Digital Commerce, IOTA Foundation and UK Finance to the FSB in response to its consultative reports on the regulation of the crypto asset ecosystem.
[xxx] This is because risks emanating from the crypto ecosystem may not always be akin to the risks posed by the traditional financial sector.
[xxxi] See for example, Digital Currencies Governance Group’s response to the FSB’s recommendation.
[xxxii] Quoted from submissions made by the Crypto Council for Innovation in response to the FSB’s recommendations. https://www.fsb.org/2023/01/public-responses-to-fsbs-proposed-framework-for-international-regulation-of-crypto-asset-activities/
[xxxiii] Per Global Digital Asset Association. See also IOTA Foundation submissions.
[xxxiv] Quoted from Crypto Council for Innovation submissions to the FSB.
[xxxv] Categorizing developers as intermediaries could stunt innovation, growth and broad involvement in this sector: see submissions by Consensys to the FSB.
[xxxvi] Ibid.
[xxxvii] Suggested by the Crypto Council for Innovation.