Regulators have crypto in their sights

When cryptocurrency prices skyrocketed last year, this created a flood of newly minted digital currency millionaires. Now we’re seeing some real-world consequences.

This week Fidelity, the wealth manager, disclosure that its clients have donated $10 billion to its charity by 2021: including $331 million in donations of crypto assets, primarily bitcoin. This is a 12-fold increase in 2020.

Some of this giving may just reflect generosity (or guilt). But prior “tax optimization” strategies have probably also stimulated it, as investors are awaiting “clarity from the Internal Revenue Service on what crypto taxation will look like in the future.” future,” Stephen Pruitt, head of Fidelity Charity, told me.

Either way, the model suggests that the once anarchic, anti-establishment crypto world is increasingly merging with the realm of tax planning and rigidly mainstream financial institutions. Is this a good thing? Many Fidelity investors (and their targeted charities) will say “yes”. But for regulators, the issue is causing growing anger ahead of this week’s meeting of G20 leaders.

To see why, see mesports report that the Financial Stability Board, a global committee of regulators and central bankers, issued before the G20.

The report notes that the crypto world has so far not posed any systemic financial risks. While its market capitalization more than triples by 2021, to reach $2.6 billion, the figure “still[s] a fraction of the total wealth of the global financial system”. And the “price spikes” have “so far remained within the crypto markets and not spilled over into financial and infrastructure markets.” Edema.

But the FSB report shows regulators are concerned that this benign picture is starting to change. It warns “cryptocurrency markets are evolving rapidly and may reach a point where they represent a threat to global financial stability.”

What worries the FSB can be summed up in four Ls: legitimacy, leverage, liquidity, and leakage.

The first of these is relatively easy to describe: the pseudo-borderless nature of cryptocurrency has made it a breeding ground for money laundering and other nefarious activities. This week, for example, a crypto research group called Chainalysis suggest that criminals got hold of $11 billion in crypto from known illicit sources by 2021 — a quadruple increase in 2020.

Leaks, however, are a more delicate matter. Until recently, most FSB regulators and central banks seemed to treat crypto assets like poker chips in a digital casino – i.e. tokens that periodically cause wild dramas on the betting table but don’t have much of an impact on the “real” world beyond the casino walls, as they cannot be used outside unless converted.

But the FSB now thinks the risk of infection or leakage is increasing. One reason is the issuance of so-called stablecoins – cryptographic tokens backed by real assets, such as dollars – has increased from $5.7 billion at the end of 2019 to $155.6 billion in January.

Another reason is that mainstream investors and institutions are now incorporating cryptocurrencies into broader portfolio strategies. This means that any future collapse in cryptocurrency prices could translate to other asset classes if investors need to liquidate their portfolios.

The other two “Ls,” mismatched leverage and liquidity, could exacerbate that mayhem. FSB notes: The latter poses a problem because network institutions that issue stablecoins may not have enough liquid assets to actually buy back investor claims. That creates runaway risk, the kind we often see in the banking world (and witnessed with credit vehicles during the 2008 financial crisis).

Meanwhile, the leverage issue is causing concern as anecdotal evidence shows that debt is increasingly being used to further raise crypto stakes. To cite just one example: FTX Trading, a cryptocurrency company, recently listed bitcoin products on the Austrian exchange with 20x leverage. And while anecdotal evidence also suggests that leverage has recently decreased, along with the bitcoin price, that “L” tends to trigger a Pavlovian reaction from regulators today, given the role leverage plays. The trap was concealed in the 2008 crash.

Of course, crypto enthusiasts would argue that crypto anxiety seems a bit ironic, given all the other leverage issues the FSB has sometimes downplayed. The logical point: many major financial asset classes are struggling with inadequate leverage and liquidity, due to years of excessively loose monetary policy. Falling Treasury prices will be more destabilizing than bitcoin prices.

However, whether you approve of the FSB’s concerns or not, the bottom line investors need to understand is this: regulatory scrutiny is growing – fast. Indeed, the G20 will likely accept the FSB’s requests for new data reporting requirements and other prudential controls.

And while it may take time to implement these proposed reforms (and the global rollout will certainly be uneven), those crypto millionaires need to prepare for a new world. In other words, in 2022, we will hear more about crypto tax planning; Not all “charity” is pure charity.

gillian.tett@ft.com

https://www.ft.com/content/847c5472-65b6-4a13-a951-bcf02c07fddb Regulators have crypto in their sights

Adam Bradshaw

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