The Financial Stability Board, an advisory body to the G20 organisation, has published a report on the implications of cryptocurrency. The report is considerably more pessimistic than the one that it published a few months ago.

It has now concluded that cryptocurrency poses a number of potential threats to financial stability. The risk is not significant currently because of the limited size of the market, but the risk becomes more significant as the market grows.

Its conclusions are based on a “monitoring framework” which it has developed, “predominantly based on public data”.

Financial institutions exposed to cryptocurrency in one third of G20 countries

The FSB says that cryptocurrency trading platforms operate in the vast majority of its member jurisdictions, and regulated financial institutions were dealing with them in some form in roughly one third.

It has concluded that cryptocurrency “lack the key attributes of sovereign currencies”, but could be harmful to financial regulators, financial institutions, and the public.

The risks identified are as follows:

1. Market liquidity

It says that cryptocurrency ownership is concentrated amongst a relatively small number of people. This limits the ability to transact and means that volatility becomes especially harmful.

The market is fragmented because many venues are not registered, meaning that the market network is not complete and customers are not protected by law.

Cryptocurrency-based derivatives were hoped to bring more depth and liquidity to the market, but in reality their impact has been insignificant.

2. Volatility

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Bitcoin and Ethereum displayed changes in price (as of 4 October 2018) up to 13 times higher than that of the assets like the euro and gold. This causes a risk of market crash.

3. Leverage

Leverage, or credit extended by a trading company, harms market stability in a number of ways.

Citing a recent survey, the report says that nearly 20 percent of hodlers bought their cryptocurrency with debt. However it adds that its information on this subject is far from complete.

4. Technology risks

It notes that there are “concerns about the long-term viability of ‘mining’-based systems”, because of energy consumption rates and the tendency to monopoly. Their decentralised nature of the networks makes them difficult to fix and vulnerable to hacks.

5. Institutionalisation

If cryptocurrency becomes institutionalised, the FSB warns that its weaknesses could erode confidence in financial institutions and authorities.

“Vigilant monitoring is needed”

The FSB consists of representatives from the finance departments and central banks of all members of the G20 – 68 different institutions in all. It is chaired by the Governor of the Bank of England, Mark Carney. It is funded by the Bank of International Settlements.

It is a purely advisory body, without enforcement powers.

In July 2018, it released a report on cryptocurrency which concluded that cryptocurrency was not yet a threat. Now it calls for “vigilant monitoring is needed in light of the speed of market developments.”

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