The European Central Bank (ECB) warned on Tuesday that cryptocurrencies will pose a risk to financial stability if the emerging sector maintains its rapid growth of the past two years and if financial firms step up their involvement.
Crypto Market Drops After Hitting a High Last Year
The crypto market fell sharply this month after the collapse of Terra blockchain coins, which challenged the stability of algorithmic stablecoins like UST, which are not backed by fiat currency.
Cryptocurrencies have exploded in size during the COVID-19 pandemic. Institutional investors in particular have been drawn to claims that bitcoin acts as a hedge against inflation and offers high returns in the face of low interest rates.
The crypto sector hit a high of $2.9 trillion last November, up from less than $300 billion at the start of 2020. Yet bitcoin, the biggest token, since November has fallen more than half, driving the value of the overall crypto market to around $1.2 trillion.
Crypto Not Suitable for Most Retail Investors
In its biannual Financial Stability Review, the ECB said exposure to crypto by banks and other large-scale financial institutions could put capital at risk and harm investor confidence, lending and financial markets.
“Systemic risk increases in line with the level of interconnectedness between crypto-assets and the traditional financial sector,” it said.
The high-leverage trading offered by crypto exchanges has seen investors borrow funds to buy greater exposure to crypto, also increasing financial stability risks, the ECB noted. In addition, data gaps in the industry also hamper financial risk assessment, it said, warning that releases from crypto exchanges and data aggregators should be treated with caution.
The ECB said crypto was not suitable for most retail investors and urged European Union authorities to approve new rules on crypto assets.
“Given the speed of crypto developments and the increasing risks, it is important to bring crypto-assets into the regulatory perimeter and under supervision as a matter of urgency,” the ECB said.
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