In 2016, most people had never heard of cryptocurrencies. Fast forward to 2021 and digital coins have taken financial markets by storm. Bitcoin, the most popular cryptocurrency and the largest by market capitalization, recently saw its price top $60,000 – and experts believe it may go even higher.

Cryptocurrencies are digital assets that rely on blockchain technology – a type of system that stores and tracks digital data. You can buy, sell, trade, and even invest in cryptocurrencies.

Although investors in cryptocurrencies like bitcoin, ethereum, litecoin, and others have seen extravagant gains over the years – experts continue to criticize digital currencies for their volatility and unregulated nature.

Global agencies are working to try and establish a policy framework to regulate and manage the exponential growth of crypto assets.

The Basel Committee on Banking Supervision (BCBS), an international banking authority, set forth a proposal for a regulatory framework in June that would distinguish stablecoins from more  speculative assets like bitcoin and other cryptocurrencies.

The aim is to encourage banks with significant cryptocurrency exposure to set aside cash in order to cover potential losses arising from the volatile nature of most digital coins.

However, the initiative was met with backlash from global banks and other financial institutions. Many believed the regulations went too far, and that banks should actually be encouraged to deepen their involvement in the crypto space – as this would help bring the emerging asset class into the eyesight of regulators.

The Global Financial Markets Association (GFMA), an advocacy group of the world’s leading financial institutions, expressed their concerns.

“We find the proposals in the consultation to be so overly conservative and simplistic that they, in effect, would preclude bank involvement in crypto-asset markets,” the GFMA wrote.

Financial regulators have concerns over cryptocurrency volatility

Stablecoins are cryptocurrencies whose market values are pegged to some external source, such as the U.S. dollar or gold. The idea is to generate a more stable cryptocurrency – which are normally notorious for constant price swings – and to make it easier to buy goods and services.

Although some stablecoins tend to fluctuate less than other cryptocurrencies, some regulators still maintain that they may not be stable enough.

Under the BCBS proposal, cryptocurrencies, like bitcoin, whose market values aren’t pegged to an underlying asset would be broadly categorized as a “Group 2” asset that comes with “additional and higher risks.” Stablecoins, on the other hand, wouldn’t be classified as Group 2.

The BCBS suggests implementing a 1,250% risk weight for Group 2 assets when calculating a bank’s capital levels (a key measure of a firm’s financial health measured by its assets minus its liabilities).

According to the BCBC proposal, “Capital [should] be sufficient to absorb a full write-off of the crypto-asset exposures without exposing depositors and other senior creditors of the banks to a loss.”

At 1,250%, the risk weight for crypto assets would be significantly higher than residential mortgages (between 50% to 100%) or junk-rated corporate bonds (typically 100%).

The banking industry insists that crypto assets are too diverse for a single, ubiquitous risk weight and maintains that the regulatory framework should take into account any hedges made by the bank. They also fear that tight regulations could stifle competition within crypto markets.

Regulatory agencies aren’t as worried about potential threats to competition as they are about financial market instability.

Last week, The Bank of England’s deputy governor for financial stability, Jon Cunliffe, warned that cryptocurrencies could spark a global financial crisis akin to the 2008 meltdown unless tougher regulations are introduced.

Cunliffe drew similarities between the crypto asset market growth rate, which skyrocketed from $16 billion five years ago to $2.3 trillion today, and the $1.2 trillion subprime mortgage market in 2008.

“When something in the financial system is growing very fast, and growing in largely unregulated space, financial stability authorities have to sit up and take notice,” he explained.

The U.S. Treasury Department is also voicing concerns and working towards their own crypto asset regulatory framework. The Biden administration has been adamant about exerting greater control over both cryptocurrencies and stablecoins.

Although no legislation has been put into effect, it’s likely this topic will continue to generate concern in both Washington and worldwide.