Federal Reserve Vice Chairman Lael Brainard said the recent volatility in cryptocurrencies has exposed “serious vulnerabilities” in an industry that needs tighter regulation.
Brainard told a Bank of England conference in London on Friday that cryptocurrencies are not yet “big enough or so intertwined” with traditional finance to pose a systemic risk, but it raises known regulatory concerns.
“Although touted as a fundamental break from traditional finance, the crypto-financial system turns out to be subject to the same risks that are all too familiar from traditional finance, such as leverage, settlement, opacity, and the transformation of maturity and liquidity,” Brainard said.
“As we work to future-proof our financial stability agenda, it is important to ensure that the regulatory perimeter includes crypto-finance.”
Crypto markets have come under relentless pressure in recent weeks, with several key players, including crypto hedge fund Three Arrows, fizzling out as a result of the market crash. Since November’s peak, popular tokens like bitcoin and ether have lost roughly 70 percent of their value.
In the wake of this market crash, Brainard questioned the common case that cryptocurrencies like bitcoin act as a hedge against inflation.
“Contrary to claims that crypto assets are an inflation hedge or an uncorrelated asset class, crypto assets have fallen sharply in value and have proven to be highly correlated with riskier stocks and risk appetite in general,” she said.
Brainard’s talk also focused on the stablecoin industry, a key factor in the broader health of the crypto market. The stablecoin is supposed to track real currencies and ensure the stability of the crypto market by offering a fast route for traders to exchange digital tokens for dollars.
“It is vital that stablecoins redeemable on demand at par in fiat currency are subject to the kinds of prudential regulations that limit run risk,” she added.
Brainard’s stablecoin comments follow the collapse of the once-popular stablecoin terraUSD and its sister token luna, a crash that wiped out billions of dollars for investors. Terra relied on computer algorithms and market demand to keep its value stable.
“Kroh Terra reminds us how quickly an asset that seeks to maintain a stable value against fiat currency can become subject to bootlegging.” The collapse of Terra and the previous failures of several other unsupported algorithmic stablecoins are reminiscent of classic startups throughout history.”
Brainard also pointed to tether — the industry’s largest stablecoin — and the significant pressure the stablecoin provider experienced in May. “As highlighted by the large recent outflow from the largest stablecoin, fiat-pegged stablecoins are highly vulnerable to a run,” she added.
In addition, Brainard’s address was aimed at cryptocurrency companies that could mirror the activities of traditional finance without equivalent regulatory standards.
She noted that many cryptocurrency trading and lending platforms do not have comparable regulation, but “also combine activities that must be separated in traditional financial markets.”
“It is important to address the mismatch and any gaps that may exist,” she said.