Bank of England sketches out regulatory approach to crypto

By Huw Jones and David Milliken

LONDON (Reuters) – The Bank of England on Thursday began sketching out Britain’s first regulatory framework for cryptoassets, saying that although the sector remained small, its rapid growth could pose risks to financial stability in future if left unregulated.

Cryptoassets have come under the regulatory spotlight amid concerns they could be used to circumvent financial sanctions imposed on Russia since its invasion of Ukraine.

“While cryptoassets are unlikely to provide a feasible way to circumvent sanctions at scale currently, the possibility of such behaviour underscores the importance of ensuring innovation in cryptoassets is accompanied by effective public policy frameworks to … mantain broader trust and integrity in the financial system,” the BoE’s Financial Policy Committee said in a statement on Thursday.

Cryptoassets, such as bitcoin and ether, are largely unregulated as they fall outside the so-called regulatory perimeter and a change of law would be needed to bring them inside the full scope of UK securities rules, a step Britain’s finance ministry is looking at.

The FPC said direct risks to financial stability from crypto were currently limited, but if the recent pace of growth is maintained, there would be risks in future.

The sector globally grew tenfold between early 2020 and November 2021, and now stands at $1.7 trillion or 0.4% of global financial assets, with over 17,000 different cryptoasset tokens in circulation.

Regulation for the sector should be based on “equivalence”, meaning that crypto-related financial services that perform a similar function to existing financial services should be subject to the same laws, the FPC said.

Until cryptoassets are brought fully under the regulatory net, the BoE is focusing on ensuring that risks from crypto are controlled in the banking sector. BoE Deputy Governor Sam Woods wrote to lenders on Thursday, noting increasing interest from banks and investment firms in the sector.

Risks from crypto should be “considered fully” by the boards of banks and they would likely need to adapt their existing risk management strategies and systems, Woods told them.

“We would also expect firms to discuss the proposed prudential treatment of cryptoasset exposures with their supervisors,” Woods said in reference to the amount of capital needed to cover any losses.

The FPC said that a major stablecoin, meaning a cryptoasset backed by a fiat currency or other asset, which does not have a deposit guarantee scheme or regime for winding itself down if in trouble, could still “meet its expectations” provided there is a regulatory framework to mitigate risks.

“The FPC judges that a systemic stablecoin that is backed by a deposit with a commercial bank would introduce undesirable financial stability risks,” it added.

The BoE and the Financial Conduct Authority will carry out further work on rules for stablecoins and consult on a regulatory “model” for systemic stablecoins in 2023, the FPC said.

(Reporting by Huw Jones and David Milliken)