The growth and increasing integration of cryptocurrencies into the world financial system has Britain's central bank worried.
As institutional and corporate allocations to crypto-assets skyrocket, the Bank of England’s latest Financial Stability report warns that stresses in crypto-asset markets could spill over into the wider financial system if their exponential growth continues unchecked.
The vast majority of this market—around 95%, the central bank opined in its December 2021 report—is made up of “unbacked” crypto-assets that “have no underlying assets.” The report opines that “Such crypto assets have no intrinsic value, are vulnerable to major price corrections and investors may lose the entire value of their investment. This price volatility makes them unsuitable to be widely used as money or a store of value.”
But given that crypto-assets account for just 1% of global financial assets, is Threadneedle Street getting itself worked up over nothing? The central bank highlighted the growth in crypto-assets’ market cap, which increased tenfold from early 2020 to around $2.6 trillion as of November 24, 2021.
A recent study by London-based Nickel Digital Asset Management reveals that 20 listed companies from North America, Asia and Europe with a market cap in excess of $1 trillion have approximately $9.6 billion invested in Bitcoin. The same study finds that a staggering $60 billion worth of bitcoins are held by various closed-ended trusts and exchange traded products.
The Bank of England estimates that crypto-assets pose a limited direct risk to the wider UK financial system. But if their rapid growth continues, they will become increasingly interconnected with the wider financial system. “For example, if institutional investors embed crypto-assets as a core part of their portfolios, a large fall in crypto-asset valuations may cause investors to sell other financial assets and potentially transmit shocks through the financial system,” write the authors of the report.
The use of leverage can amplify such spillovers, should investors be forced to meet margin calls on their crypto-asset positions by selling other assets, the report states. “Greater focus is needed,” it adds, “on enhancing the transparency of institutional investor holdings as crypto-asset markets continue to grow.”