Financial regulations should be extended to crypto before the industry becomes large enough to potentially threaten broader financial stability, according to Jon Cunliffe, deputy governor of the Bank of England.
Cunliffe has previously said that regulators should accelerate efforts to establish clear rules for crypto. The crypto market turned heads when it reached nearly $3 trillion in market capitalization last year.
But “the greater impact on the financial system may well come from the transfer of technologies developed in the crypto world to the ‘real’ world,” Cunliffe said while speaking at the Operations, Post Trade, Technology and Innovation Conference organized by the Association for Financial Markets in Europe (AFME).
The promise that this technology can make operations faster and more streamlined has prompted the traditional financial sector to experiment with it, he added. Several years ago, London-based bank HSBC said it was “investing in and developing this technology because it helps to improve efficiency.”
While Cunliffe listed a range of opportunities distributed ledger technology (DLT) and smart contracts that underlie crypto could bring to traditional asset trading, he said it did not mean regulators should wait around to regulate the crypto industry.
“Regulators need to begin extending existing standards and regulatory regimes to crypto before, not after it becomes systemically important,” Cunliffe said on Wednesday. “And done carefully, the development of regulatory regimes helps not hinders innovation by reducing the risks of confidence destroying crashes and by giving innovators a framework within which to innovate.”
The crypto markets tumbled from their near peak of $3 trillion last year to stand at $927 billion as of Wednesday after a series of large companies such as stablecoin issuer Terra collapsed earlier this year.
The U.K. already has some plans in motion to supervise crypto and DLT growth including a regulatory sandbox it plans to run next year that will let companies test blockchain-based financial services.
Opportunities and risks
Cunliffe highlighted the opportunities of using DLT technology for trade and post-trade settlements, which encapsulates all the processes that follow a trade. For instance, DLT allows both equities and debt instruments to be combined in a single ledger and facilitate instant trades. Smart contracts, which are programmable to execute different functions, offer “the potential to add layers of additional functionality and features,” Cunliffe said.
“But recognizing the opportunity does not mean that we should ignore the risks, any more than we ignore the risks in the existing structures,” Cunliffe said.
The resiliency of DLT-based systems in wider applications is yet to be determined because “the technology most widely used in existing cryptocurrencies cannot simply be copied and pasted for wide scale use in capital markets,” the deputy governor said.
Instantaneous settlements would also take away the window for error before a trade is finalized, which could end up worsening systemic risk, Cunliffe said. Another obstacle is figuring out how the technology would allow interactions between platforms, something the Bank for International Settlements has been exploring since 2020.
To combat these risks, Cunliffe implored both local and international regulators to do more to help regulate the sector.
Given the “cross-border nature of many financial infrastructure services,” there is a role for international standard setters to play in setting up the appropriate norms, Cunliffe said.
