Financial System Review—2022 – Bank of Canada

Crypto-asset ownership is also expanding, primarily as a speculative investment rather than a method of payment. In 2021, about 13% of Canadians owned Bitcoin, up from 5% in 2020. Median Bitcoin ownership was around $500, primarily for investment purposes. To date, the significant price volatility of these unsecured crypto-assets as well as high transaction costs have been the main obstacles to their wide acceptance by merchants as a method of payment. For example, the prices of crypto-assets such as Bitcoin and Ether were generally four to five times more volatile throughout 2021 than was the S&P 500 stock index. Sudden price corrections mean that investors who hold these types of crypto-assets can be exposed to significant financial losses.

Interconnections between unsupported crypto-asset markets and the financial system seem limited but growing rapidly. Institutional participation in these markets has increased in recent years. However, estimating the growth of institutional investment in these assets and related infrastructure is difficult due to the lack of readily available and consistent data on the exposures of financial system participants to these markets. Discussions with industry players suggest portfolio exposures remain low. Crypto-assets have generally become more accessible to investors in recent years with the emergence of closed-end funds, crypto exchange-traded funds, and listed companies that trade or mine crypto-assets. Additionally, hedge funds and some large pension funds would invest more in crypto-asset platforms. Crypto-assets are also increasingly integrated into the mainstream financial system (often referred to as the financialization of crypto-assets), including through the development of crypto derivatives markets and as investment assets or collateral for loans.

The Bank’s assessment that these markets are not yet systemically important is reinforced by the fact that the sell-off in crypto-asset markets in May 2022 was largely inconsequential to the traditional financial system in Canada and the rest of the world. ‘foreign.

Stablecoins aim to meet the demand for a more liquid and less volatile cryptoasset. Stablecoins play a key role in decentralized finance, a suite of alternative financial products offered in crypto-asset markets that mimic traditional financial services (e.g., lending, insurance, asset management, and custody) . Like other crypto-assets, stablecoins can also pose risks to financial stability if widely adopted without appropriate regulatory safeguards, particularly regarding the ability of issuers to meet redemptions (Box 5).

The lack of adequate regulatory frameworks for crypto-assets is a key driver of this vulnerability. Companies operating in crypto-asset markets often perform functions similar to those of traditional financial institutions. They share many risks but are not subject to the same regulatory standards. Until this regulatory loophole is closed, investors and end-users of unsecured crypto-assets are at increased risk of financial loss from events such as fraud, cyber-attacks, or the failure of a custodian or custodian. a key service provider. Moreover, a significant challenge for the regulation of crypto-assets is that they are easily used for cross-border transactions. This can be positive for economic activities such as remittances, but it creates opportunities for illegal transactions such as money laundering and terrorist financing. Effective regulation of these markets will require countries to coordinate closely to ensure consistency and prevent criminals from exploiting regulatory loopholes.

The regulatory response is taking shape but needs to grow. Regulators around the world have recognized the risks posed by weak regulatory frameworks and are working to address them. For example, in March 2022, the US administration issued an expansive executive order:

  • launch a digital asset strategy
  • asking many federal government agencies to jointly review the regulation of digital assets

In Canada, provincial securities authorities have issued guidelines for the regulation of crypto-assets and crypto-asset trading platforms that meet the definition of securities or securities market infrastructure, respectively. The federal government announced in its 2022 budget that it would conduct a legislative review of the financial sector. The first phase of this review will focus on digital currencies, including crypto-assets and stablecoins. As part of this work, the government will examine:

  • regulatory approaches to maintain the safety and stability of the financial system as digital currencies become more common
  • the potential need for a central bank digital currency in Canada

Additionally, a Bank of Canada official currently chairs the FSB Stablecoin Regulatory Issues Working Group which works together to promote globally coordinated regulatory responses to stablecoins.

More generally, federal and provincial authorities should move quickly to develop an integrated regulatory regime for crypto-assets, or else this vulnerability could continue to grow.

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Don F. Davis