Fed Vice Chair Warns Bank Involvement in Crypto of Sparking Financial Instability

Federal Reserve Vice Chairwoman Lael Brainard urged policymakers to toughen up regulatory scrutiny on the crypto industry in a speech given at the Bank of England conference on Friday. Once again, the Chair emphasized the risk of the crypto market crash spilling over to the core financial ecosystem because of the lack of targeted regulation on banking institutions and stablecoin issuers.

Targetting DeFi Protocols

Brainard’s speech pointed out the risk of the crypto market, in fact, as similar to the traditional markets, though the former vows to operate differently.

Such instability has been shown in crypto platforms that have fallen prey to the risks, including “runs, fire sales, deleveraging, interconnectedness, and contagion,” as clearly illuminated in firms recently imposing withdrawal freezes and even filing bankruptcies amidst a market downturn.

“Large crypto players that used leverage to boost returns are scrambling to monetize their holdings, missing margin calls, and facing possible insolvency.”

The recent collapses of crypto lending firms have made it urgent for policymakers to tighten up loopholes regarding such platforms not engaging in compliance as mandatory for traditional finance. Platforms that offer hybrid services with features of both decentralized and centralized finances should not be treated with exceptions, Brainard noted.

Adding on top of her take on the deepened selloffs, she called DeFi protocols “presenting novel challenges” due to the peer-to-peer nature of such activities, the absence of validated identities, and more. Meanwhile, she expressed concern about the new technology as a facilitator of potential financial crimes:

“The permissionless exchange of assets and tools that obscure the source of funds not only facilitate evasion, but also increase the risk of theft, hacks, and ransom attacks. “

Bank Involvement in Crypto

According to the Fed Chair, the increasing bank involvement in crypto and stablecoin activities ranging from custody and issuance to customer facilitation could spark financial instability, as banks usually act as the intermediaries between digital asset firms and users. A bloody crash in the crypto space could spread to implicate banks closely connected to the broader market.

Though the interconnectedness between crypto and the core financial system has not reached the level that could pose systemic risk, admitted Brainard, relevant banking institutions and stablecoin issuers are the ones regulators should pay attention to.

Commenting on the negative headlines surrounding the stablecoin industry, she categorized such assets pegged to fiat currency as “highly vulnerable to runs,” thus suggesting that they should be subject to the types of scrutiny that have historically applied to private monies.

Featured Image Courtesy of Candorium