The cryptocurrency industry needs strong regulation before it becomes so pervasive that it poses risks to financial stability, Federal Reserve Vice Chairman Lael Brainard said on Friday, noting that the recent turmoil in the space has shown that cryptocurrencies are under suffer from the same risks as the traditional financial sector.
“It is important that the foundations for sound regulation of the crypto-financial system are laid now, before the crypto ecosystem becomes so large or interconnected that it could pose risks to the stability of the broader financial system,” said Ms. Brainard in prepared remarks for a Bank of England conference in London.
The risks of loosely regulated cryptocurrencies and stablecoins operating in a legal gray area have come into focus with the sharp downturn in the crypto market and the collapse of major “stablecoin” TerraUSD. Leading cryptocurrency Bitcoin has fallen more than 75 percent from its all-time high in the past seven months.
The crash has brought down a number of major crypto companies, including Celsius Network, which media reports have suspended customer withdrawals and may be looking to restructure. Toronto-listed Voyager Digital and Singapore-based crypto hedge fund Three Arrows Capital both filed for bankruptcy this month.
While the crypto industry has touted digital assets as fundamentally different from traditional finance, Ms Brainard said the sector has proven vulnerable to the same risks and should be governed by the same rules.
Those risks include leverage, fire sales, opacity, maturity and liquidity mismatches and contagion, she said, adding that new technology and financial engineering alone cannot turn risky assets into safe ones.
“Future financial resilience will be significantly enhanced if we ensure that the regulatory perimeter encompasses the crypto-financial system and reflects the principle of equal risk, equal disclosure and equal regulatory outcome,” said Ms. Brainard.
National and international collaboration is needed, Brainard said, to ensure compliance with existing regulations and tailor new ones, she added.