Systemic risks of cryptocurrency adoption by traditional finance according to crypto institutions – Ledger Insights

Regulators repeatedly raise concerns about whether crypto-assets can create financial stability risks for the economy as they become mainstream. Yesterday, the leaders of major institutional crypto firmsCustodia Bank, brokerB2C2, and custody firmsFireblocksandAnchroagespoke about some of the settlement risks and legal uncertainties and how they might be addressed. They were talking at the Financial Times Crypto and Digital Assets Summit.

Former Morgan Stanley banker Caitlin Long said that Bitcoins going to take a G-SIB (global systemically important bank) down at some point because they dont understand that the settlement risk is so different between Bitcoin and traditional assets. Long is the founder and CEO of Custodia Bank (formerly Avanti).

She was referring to how Bitcoin settles within minutes and transactions are irreversible. In contrast, sometimes cryptocurrency payments are made using fiat currency, and U.S. payments invariably clear the next day.

Unlike traditional finance, theres no central counterparty, which means theres counterparty risk. Hence, if settlement is made using fiat currency you potentially have the timing mismatch that Long referred to.

Max Boonen, founder atSBI-owned crypto brokerage B2C2, didnt entirely agree about the extent of the credit risk. In his view, the average cryptocurrency transaction is quite small, and a $100 million transaction in the crypto sector would be considered absolutely massive. Given the crypto market is more retail focused, he sees the credit risks compared to the firms substantial capital bases as insignificant.

He pointed to the large sums raised byAnchorageandFireblocks, with the latter pulling in more than $1 billion in venture capital. On the flip side, he believes there are bigger risks to retail investors with cryptocurrency exchanges.

The other key point is that in the peer-to-peer (p2p) environment, the majority of transactions are settled withstablecoinsas atomic swaps or delivery versus payment, which removes the risk.

Stablecoins address the counterparty and timing difference risks, but they introduce others, such as liquidity risk. While better quality stablecoins such as USDC and Paxos primarily use Treasuries as backing assets, Long pointed out that if you need to sell the Treasuries, they settle the next day.

However, a stablecoin ideally needs to be redeemable instantly, especially in a run situation, which points to the need for a federal reserve account. Her firm, Custodia, has applied for a banking license to support a digital dollar product that she described as more like a cashiers check than a stablecoin.

As an aside, its notable that BlackRock recently invested in Circle, the issuer of the USDC stablecoin, andplans to explore USDC for securitiessettlement.

The potential centralization risks of stablecoins were not mentioned, but what was discussed is that the onramps for the $50 billion USDC stablecoin are currently primarily through just two banks, Silvergate and Signature Bank.

However, Fireblocks CEO Michael Shaulov commented that BNY Mellon would be added to the list. The bank recently announced a deal with USDC issuer Circle, but ascustodian of the backing assets, rather than onramp. Shaulov should know becauseFireblocks technology is used by BNY Mellon, which is also an investor. We reached out to BNY Mellon for confirmation but did not receive a response in time for publication.

Moving on to other risks, Shaulov noted that many institutions use multiple custodians to address financial and technology risks.

Another risk highlighted by Caitlin Long is that the BIS Basel Committee has not yet finalized the capital that needs to be set aside by banks underBasel III rules if they hold cryptocurrencies. That means big institutions dont want to hold crypto on their balance sheets.

The final risk raised by Long was a legal one. Its not the regulatory uncertainty around crypto that everyone talks about but legal certainty around the cleared title to a crypto-asset. There hasnt been a lot of litigation in this area which means that judges dont have a roadmap set by legal precedent.

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Systemic risks of cryptocurrency adoption by traditional finance according to crypto institutions - Ledger Insights