Bank of England Outlines Framework for Regulating Crypto Assets

The Bank of England, the Central Bank of the United Kingdom, announced Thursday the first regulatory framework for crypto assets in the country. The UK Central Bank made a move as it admitted that though the crypto sector remained small, its rapid growth could pose risks to financial stability in future if it remains unregulated.

Of late, crypto coins have come under the regulatory spotlight amid concerns they can be used to circumvent financial sanctions imposed on Russia since its invasion of Ukraine.

In a statement on Thursday, the Central Bank’s Financial Policy Committee (FPC) stated: “While crypto assets are unlikely to provide a feasible way to circumvent sanctions at scale currently, the possibility of such behaviour underscores the importance of ensuring innovation in crypto assets is accompanied by effective public policy frameworks to... maintain broader trust and integrity in the financial system.”

The Financial Policy Committee said that although direct risks to financial stability from cryptocurrency are currently limited, if the recent growth continues, there would be risks in the future. The committee admitted that crypto-assets like Bitcoin and Ether are largely unregulated as they fall outside the setout regulatory scope. However, the committee now considers a change of law to be made to bring cryptocurrencies inside the full scope of UK securities rules.

According to the FPC, regulation for the crypto sector should be based on “equivalence”. This means that crypto-related financial services that function similarly to the existing traditional financial services should be subjected to the same laws.

The FPC further stated that setting up such a regulatory framework would help mitigate risk associated with stablecoins that do not have a deposit guarantee scheme or regime for winding themselves down if in trouble.

The FPC disclosed that the Central Bank and Financial Conduct Authority (FCA) will conduct further tasks on rules for stablecoins and consult on a regulatory “model” for systemic stablecoins in 2023.

While the UK Central Bank is working on bringing cryptocurrencies fully under the regulatory framework, the regulator has been focusing on ensuring that risks from crypto-assets are controlled in the banking sector.

On Thursday, Sam Woods, the Deputy Governor at the Bank of England, wrote to local lenders about banks and investment firms’ rising interest in offering crypto trading services.

Woods told lenders that the boards of banks should fully consider risks from crypto-assets and therefore adapt their existing risk management strategies and systems. “We would also expect firms to discuss the proposed prudential treatment of crypto-asset exposures with their supervisors,” Woods said in reference to the amount of capital required to cover any losses.

The Central Bank considering CBDC

This is not the first time the UK Central Bank has warned on cryptocurrency risks. Late last year, a senior Bank of England official warned that fast-growing crypto-currency assets could pose a danger to the established financial system. In December, Sir Jon Cunliffe, the Deputy Bank Governor, said that although not much of UK households’ wealth is currently held in assets like Bitcoin, they are becoming more mainstream. The executive emphasized that cryptocurrencies had been “growing very fast”, with people like fund managers wanting to know whether they should hold part of their portfolios in crypto assets.

When cryptocurrency becomes integrated into the financial system, a major worry is that big price correction could significantly affect other markets and affect established financial market participants. Mr. Cunliffe, therefore, urged authorities to beef up measures and get a regulatory framework in place to contain the crypto risks.

One of the counters that the Bank of England has taken is to embark on research and exploration for a potential launch of its own cryptocurrency (a central bank-backed digital currency) to tackle some of the challenges posed by cryptocurrencies such as Bitcoin.