European financial supervisors are closely monitoring cryptocurrencies and proactively assessing potential risks of systemic crises associated with the sector. The recent approval of the MiCA regulation by the Economic and Financial Affairs Council of the European Union reflects the continental regulator’s focus on the complexities arising from the convergence of traditional finance and cryptoassets. The European Systemic Risk Board (ESRB) specifically identifies stablecoins as a potential danger, warranting attention within the framework of financial stability.
Interconnections between Traditional Finance and Crypto Pose Global Consequences
Established in response to the sovereign debt crisis the ESRB plays a vital role in macro-prudential surveillance to ensure economic stability within the European Union. In its comprehensive 77-page report on potential systemic risks caused by a crypto crisis the ESRB acknowledges that the current risk of contagion to traditional finance is minimal. However it notes sporadic correlations between crypto-asset booms and busts and traditional finance presenting one of the three nightmare scenarios envisioned. The increasing intertwining of traditional finance (TradFi) and the crypto sector amplifies the global ramifications of crises on either side. Silicon Valley Bank, Silvergate Bank and Signature Bank are cited as examples illustrating these risks.
Stablecoins Emerge as Primary Concern for Frankfurt Authorities
The ESRB’s primary concern revolves around stablecoins particularly regarding the backing of monetary reserves or financial assets held by traditional financial institutions. In the event of a bank run where doubt arises about the stability of a specific stablecoin users may rapidly withdraw their funds potentially triggering a devaluation of the stablecoin’s value as observed during the micro-crisis surrounding USDC. This scenario poses a risk to the stability of venerable financial institutions.
“A run on a reserve-backed stablecoin would generate a forced sale of tradable debt and withdrawals from banks. There is always the possibility that this will turn into a wider panic.”
The ESRB recognizes the increasing use of cryptocurrencies for payments which exposes more individuals to industry crises. Combined with the growing interconnections between traditional finance and the crypto sector this could lead to systemic risks if a severe crisis occurs within the crypto space.
The European Systemic Risk Board highlights the importance of the MiCA regulatory framework in overseeing the sector. However it acknowledges the need for further expansion of this regulatory framework to effectively address the complexity of the crypto-asset sector.