Bank of England concerned over the rapid growth of crypto and DeFi

Bank of England recently expressed its assessment of the growing crypto markets and decentralized finance (DeFi). While the monetary authority acknowledged the benefits such innovations can bring, it also pointed out the financial risks they may pose to the country’s financial stability.

In its Financial Stability Report released on Monday, the Bank of England acknowledged the rapid growth of the crypto industry which has grown tenfold since 2020 to around $2.6 trillion as of November 24, 2021 or around 1 percent of global financial assets. However, the bank pointed out that the “vast majority of this market (around 95 percent) is made up of ‘unbacked’ crypto assets that have no underlying assets.”

“Such crypto assets have no intrinsic value, are vulnerable to major price corrections and investors may lose the entire value of their investments,” the bank said. “This price volatility makes them unsuitable to be widely used as money or a store of value.”

The monetary authority said that direct risks from crypto assets to the stability of the U.K. financial stability are limited at the moment. However, considering the rapid pace of growth and their increasing connectedness to the financial system, crypto-assets will present a number of financial stability risks.

“Material growth in banks’ exposures to unbacked crypto assets would expose them to financial, operational, and reputational risks,” the BOE said. No major banks in the U.K. have direct exposure to crypto but they are starting to offer related services such as custody and derivatives trading, according to the central bank.

The bank also pointed out that if institutional investors that hold crypto as a core part of their portfolios could sell other financial assets when cryptos prices fall. This action, in turn, could send shocks through the financial system.

The central bank is also concerned over the rapid growth of decentralized finance, which can replicate a wide range of financial products and services such as insurance, trading and lending. “DeFi demonstrates the increasing complexity, and potential for new risks in the crypto assets system,” BOE said.

Bank of England recommended enhanced regulatory and law enforcement frameworks, both domestically and at a global level. These measures are aimed to influence the developments in the crypto markets so risks can be managed.

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