In a speech at the Bank of England conference on Friday, Lael Brainard, the vice chairwoman of the Federal Reserve, urged decision-makers to increase regulatory scrutiny of the cryptocurrency industry. The Chair emphasized that the absence of targeted regulation on banking institutions and stablecoin issuers poses a risk of the crypto market crash spreading to the core financial ecosystem.
Focusing on DeFi Protocols
Despite the cryptocurrency market’s claims to operate differently from traditional markets, Brainard’s speech highlighted the risk that it shares with the latter.
Crypto platforms that have been vulnerable to risks like “runs, fire sales, deleveraging, interconnectedness, and contagion” have demonstrated such instability, as amply demonstrated by businesses that recently imposed withdrawal freezes and even filed for bankruptcy amid a market downturn.
Large cryptocurrency players who used leverage to increase returns are frantically trying to sell off their holdings, missing margin calls, and possibly going bankrupt.
It is urgent for policymakers to close loopholes regarding such platforms not adhering to compliance as required for traditional finance in light of the recent collapses of crypto lending firms. Platforms that offer hybrid services that combine elements of centralized and decentralized finances shouldn’t be given special treatment, according to Brainard.
She added that DeFi protocols “present novel challenges” because of the peer-to-peer nature of such activities, the lack of validated identities, and other factors to her analysis of the deepened selloffs. She also voiced concern over the new technology’s potential to facilitate financial crimes:
The risk of theft, hacking, and ransom attacks is increased by the permissionless exchange of resources and tools that hide the source of funds, in addition to making tax evasion easier.
Bank Participation in Crypto
The Fed Chair claims that as banks typically serve as the middlemen between providers of digital assets and customers, their growing involvement in crypto and stablecoin activities, such as custody and issuance, could lead to financial instability. Banks with close ties to the larger market could be implicated in a bloody crash in the cryptocurrency space.
According to Brainard, relevant banking institutions and stablecoin issuers are the ones regulators should focus on even though crypto and the main financial system are not yet sufficiently intertwined to pose a systemic risk.
She labeled assets backed by fiat currency as “highly vulnerable to runs” in response to the negative press surrounding the stablecoin sector, implying that they should be subject to the same level of regulation as private funds historically.