Cryptocurrency trading is “too dangerous” to remain outside mainstream financial regulation and could create a “systemic problem” without action, the Bank of England’s deputy governor has warned.
Speaking for the first time since the founder of crypto-trading platform FTX was arrested and charged with massive fraud, Sir John Cunliffe told Sky News the bank was considering regulation to protect retail investors in the “casino” of crypto-trading as well as -wide financial system of potential crypto shocks.
Sam Bankman-Fried was extradited Wednesday from the Bahamas to the United States, where he will appear in court in New York charged with eight counts of fraud, money laundering and campaign finance violations.
The FTX collapse left more than one million customers unable to withdraw about $8 billion worth of assets.
Prosecutors allege he used FTX customers’ money to cover losses at his private crypto hedge fund Alameda Capital in what the company’s new CEO told Congress was “old-fashioned abuse.”
An estimated 80,000 of FTX’s customers are based in the UK, with individual liabilities of up to £5m in savings according to a lawyer acting for dozens of victims.
Louise Abbott, a crypto fraud specialist, told Sky News: “These individual investors have invested anything from a few thousand pounds to around £5 million, such huge sums of money, all completely frozen, I’ll use the word frozen rather than lost, because hopefully they will get something back at some point. But that’s huge money, huge money, lost or stuck or frozen in time.”
Crypto reliability
The episode is a huge blow to confidence in cryptocurrencies, digital assets that derive their value not from government support but from relative scarcity and the willingness of other investors to trade them.
Mr. Bankman-Fried had developed connections in Washington and on Wall Street, making millions of dollars in political donations and attracting high-profile investors to his platform.
Its fall highlighted the volatility of crypto investment and the lack of regulation in an industry that, despite widespread skepticism, is attracting increasing attention from the financial mainstream.
Regulatory efforts
In the UK, regulators have tried and failed to impose their court act on offshore crypto exchanges, while the government has a goal set out in April by Rishi Sunak when he was chancellor to make the UK a “global hub for crypto assets’, an ambition that largely depends on effective regulation.
Sir John, deputy governor in charge of financial stability, told Sky News the bank’s regulatory efforts are aimed at protecting individuals and maintaining financial stability.
Image: Bank of England Deputy Governor John Cunliffe
“There is a lot of activity that has developed over the last 10 years around the trading and selling of crypto assets, assets without any intrinsic value, so they are extremely volatile. And all of that has grown out of regulation,” he said.
“What we saw in FTX … is a range of activities that in the regulated financial sector would have certain protections. We saw things like clients’ money appearing to disappear, conflicts of interest between different operations, transparency, auditing and accounting.. All the maybe boring things that happened in the normal financial sector didn’t actually happen in this set of activities. And as a result, I think a lot of people lost a lot of money.”
Comparing crypto trading to a casino, Sir John said investors who want to speculate should be able to do so without the risk of losing access to their funds.
“In my opinion, it’s actually gambling, but we allow people to gamble, so if you want to engage in it, you should be able to do it in a place that’s regulated in the same way as if you’re gambling in a casino is regulated. You have to have the full information on the box about what you’re doing.”
The bank also has to deal with the risk to financial stability that could arise from digital assets, as institutional investors and banks explore exposure to around $1 trillion worth of cryptoassets.
“This trading of crypto assets was not large enough to destabilize the financial system, but it began to develop links with the financial system,” Sir John said. “I don’t know how this is going to play out. But we had banks and investment funds and others who wanted to invest in it. I think we need to think about regulation before it integrates with the financial system and before we have a potential systemic problem.
“So I don’t think it’s going to be possible to say that this can just be kept out of the financial system. It’s too dangerous. I think it’s difficult but possible to say, let’s bring it in where and when we think we can manage the risk to the standards we’re used to.”
Blockchain potential
Although cryptocurrencies have proven consistently volatile since Bitcoin’s inception 14 years ago, the underlying technology, blockchain, is seen as having significant potential in industries to manage data and speed up and simplify transactions.
Blockchain provides proof of transactions in a public record known as a distributed digital ledger.
Each new cryptocurrency exchange is recorded in a “block” that is added to the “chain” containing details of the new transaction and the previous transaction, meaning it can only be forged by changing all previous links.
The system is maintained and controlled by each computer connected to the network, rather than by a central monitoring facility.
Mercedes is exploring the potential of blockchain to manage data that will enable autonomous driving, while Vodafone is exploring its utility in managing the billions of microtransactions that will be facilitated by the next generation of internet technology.
Smart money could also simplify global supply chains, with the prospect of micro-transactions using stable tokens to be linked to individual parts in production processes.
“There are technologies here that could, and I stress, could be of real benefit in the normal financial system, more efficient ways of doing things, potentially more sustainable ways of doing things,” Sir John said.
“This has not been proven in the crypto world. But if we can provide a regulatory space where people can see if they can develop products using this, we might be able to take advantage of some of these technologies.”
The Bank of England’s own digital coin
As part of this process, the Bank of England is consulting on plans to develop its own central bank digital coin, an electronic version of sterling that will carry the same security as a pound coin, but with the digital flexibility that could one day replace cash Cash.
“Physical money will always be provided by the bank as long as people want it and many people depend on it. But they are not fully usable in the way we live now. So the question for the Bank of England is, as a way that we as society change as we live our lives more digitally, should we continue to provide money to the public that can be used in a range of transactions?
“It would be the digital equivalent of the ‘I promise to pay the bearer’ promise, which is ultimately the basis of trust in money in the UK. Whenever you want, you can turn that money you’re holding in the bank into basically Bank of England money backed by the government with that promise to pay the bearer.
“We want to ensure that as physical money becomes less usable in many parts of the economy, maybe we need to offer something digital to provide that foundation.”
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