Crypto exchanges’ bundling of services threatens stability, says Bank of England official

Crypto exchanges such as the bankrupt FTX that bundle together services kept separate by mainstream institutions should be more tightly regulated before they become a risk to the financial system, a senior Bank of England official has warned.

In a speech on Monday, Sir Jon Cunliffe, deputy governor of the Bank of England, said digital asset exchanges created risks to their market by operating businesses that encompassed trading, lending, clearing and custody of client assets.

Traditional markets maintain careful separation between these different roles to guard against risks, he said.

Cunliffe’s comments follow a string of corporate failures in the crypto market this year as prices have tumbled, topped by this month’s collapse of FTX, a cryptocurrency group valued at $32bn in January. Cunliffe said the experiences of the past year had shown crypto was not yet a stable market.

“Part of this is because, its foundation is completely unbacked instruments of extreme volatility that can swing wildly in value,” he told a conference at Warwick Business School.

“But part is also because the crypto institutions at the centre of much of the system exist in largely unregulated space and are very prone to the risks that regulation in the conventional financial sector is designed to avoid.”

The sudden failure of FTX, considered until recently one of the most responsible crypto venues, has heaped pressure on other exchanges. Changpeng Zhao, Binance chief executive, has warned that FTX’s collapse will increase regulatory scrutiny of its surviving peers.

Cunliffe’s remarks suggest the blurred lines between different roles played by crypto venues will be a focus for regulators, along with the need for “transparency in corporate structures, governance, audit and systems and controls”. 

The central banker also highlighted the risk of using crypto tokens as collateral. FTX and its sister trading company Alameda’s heavy reliance on the exchange’s own token FTT was a key factor in their collapse.

“A firm accepting its own unbacked crypto asset as collateral for loans and margin payments, as there are indications may have happened with FTX, creates extreme ‘wrong way’ risk,” said Cunliffe.

He restated the BoE’s position that crypto markets do not yet have the scale or close links to traditional markets to threaten wider financial stability but said regulators needed to protect consumers.

“We should not wait until it is large and connected to develop the regulatory frameworks necessary to prevent a crypto shock that could have a much greater destabilising impact,” he said.

FTX’s failure has prompted calls by some in the crypto industry to move away from centralised exchanges and towards decentralised finance protocols, where trading and lending are managed automatically by computer programmes.

Cunliffe voiced doubt that these protocols were robust enough to perform important market functions, questioning whether they were truly decentralised in practice.

“From the standpoint of a financial stability authority and a financial regulator, I have yet to be convinced that the risks inherent in finance can be effectively managed in this way,” he said.

The UK is legislating to extend its existing regulatory regime for e-money and payment systems to cover the use of “stablecoins” — cryptoassets backed by an asset such as a currency.

The BoE will have responsibility for payment systems that are systemic or likely to become so, and Cunliffe said it would consult early next year on a detailed regulatory framework to ensure stablecoins used in those systems met the same standards expected of commercial money.

He added that FTX’s demise would not alter plans by the BoE and Treasury to create a “digitally native pound sterling”, with a consultative report setting out the next steps due to be published at the end of the year.