UK Regulators Say Crypto Adoption Poses Financial Risk, Call for More Oversight

The U.K.’s central bank on Thursday warned that crypto could pose a risk to markets if it continues to grow and called for an expansion of powers to oversee the financial assets.

The London-based regulators worry that international norms could come too late to control financial market risks, and the Bank of England has urged U.K. banks to approach virtual assets with utmost caution.

With a market capitalization worth around 0.4% of the world’s financial assets, crypto and decentralized finance (DeFi) pose a limited risk to financial markets at this time. Regulators, however, are worried that the growth of blockchain technology means that could soon change.

“If the pace of growth seen in recent years continues, and as these assets become more interconnected with the wider financial system, crypto assets and DeFi will present financial stability risks,” according to a report published by the Bank of England’s Financial Policy Committee (FPC), which is responsible for monitoring stability risks.

“Enhanced regulatory and law enforcement frameworks are needed, both domestically and at a global level,” the report added. It also called on other regulators to ensure that markets don't overheat, to stop financial firms from taking unnecessary risk and to curb scams and market abuse.

Bank of England Governor Andrew Bailey on Wednesday called for “high levels” of international collaboration to stop decentralized finance from spiraling out of the authorities’ control. Bailey added that this will take time. In the meantime, U.K. watchdogs appear to be worried about loopholes in the system.

“There is currently scope for regulatory arbitrage, and there is a danger that risks grow rapidly before an internationally agreed framework is in place,” the FPC said.

The Basel Committee on Banking Supervision, a global organization, is due to establish rules that would tell banks how careful they need to be when investing in crypto, but appears to be dragging its feet after a first draft met a slew of opposition from financial institutions that said the regulators were being far too cautious.

Sam Woods, CEO of the Prudential Regulation Authority (PRA), which is responsible for checking the books of individual banks and insurers in the U.K., said in a letter dated Thursday that the PRA is also planning to vet individual crypto exposures in a survey that will take place this year.

“Many of these markets are new and untested,” Woods said, referring to the “extreme volatility and/or limited price history of these [crypto] assets.”

In most cases, banks would have to deduct any digital asset holdings from their capital, as well as plan for specific extra risks like fraud or cyberattacks, he said. This means that, unlike conventional financial assets like mortgages, a banks’ store of crypto cannot be used to vouch for further lending, Woods added.

That warning was echoed by the Financial Conduct Authority (FCA), which is responsible for overseeing traditional finance. Firms should be clear and honest with their clients when selling crypto assets, even though they technically don’t count as financial products and so lie outside of the FCA’s remit, the regulator said on Thursday.