In the last fourteen years since the emergence of the crypto sphere has grown steadily, and more recently, since the outbreak of the Covid-19 pandemic, the world witnessed a further expansion of this segment. In January 2020, the total capitalization of crypto-assets totalled about $200 billion by November 2021, at its peak, it had reached about 3 trillion dollars, with a growth of 1400 per cent in less than two years.
But the contemporary market has significantly shrunk: it remains well above January 2020 but about 60 per cent down from a record high. Recent events have taught us some lessons about crypto-assets and made a clearer case for policy interventions in this field. Whereas the interest of retail customers seems very often driven by speculative intentions, we have witnessed how some crypto-assets might be perceived as an alternative asset class or even as a store of value in difficult times.
Despite the intrinsic fragilities and weaknesses of this novel market, financial intermediaries and policymakers alike are keen on assessing the potential of its technological underpinnings, with a view to “rewiring” financial services and delivering more efficient and transparent financial markets. The road toward significant, safe use cases is yet to be built and regulation has a sizable stake in this venture, in the narrow path between supporting innovation and mitigating its risks.
In a recent 40-page report titled “Markets, Infrastructures and Payment Systems,” the Central Bank of Italy has taken a firm stance on stablecoins, stating that they have not proved to be stable at all.
“Indeed, stablecoins – which are sometimes depicted as an efficient alternative in the market for cross-border payments – have not proved stable at all,” the paper noted; the report emphasizes the need for a strong, risk-based regulatory framework to address the potential risks associated with stablecoins and prevent a worst-case scenario—a “run” on stablecoins.
The bank stated that the industry must also dispel “the decentralization illusion” by recognizing that the majority of decentralized protocols are run by primary stakeholders who can frequently “extract ownership benefits.” The bank added that “Such projects should be brought back to traditional, accountable business structures as a pre-condition for operating in the regulated financial sector.”
The bank calls for a robust, risk-based regulatory framework to address the potential risks associated with stablecoins. The report highlights instances that have raised concerns about the stability of stablecoins, such as the de-pegging of Terra’s stablecoin and a notable run on Tether.
The Central Bank of Italy’s report argues that the rise of cryptocurrencies, combined with the unregulated nature of the market and the occurrence of “boom and bust cycles,” has caused significant harm to consumers.
The bank further emphasizes the importance of synchronizing policy interventions on stablecoins and DeFi, as the diffusion of stablecoins is likely to stimulate new waves of DeFi innovation and increase the interconnection between traditional and decentralized finance. Additionally, the Italian banking authority draws attention to the instability of stablecoins by referencing the collapse of Terra’s algorithmic stablecoin, TerraClassicUSD (USTC), in May 2022.
The report further underlines that the crypto ecosystem is a complex, layered combination of operators, arrangements, and technical infrastructures, which hardly fits traditional regulatory frameworks. The challenges facing legislators and financial authorities are equally layered and escape one-size-fits-all solutions.
Faced with policy options ranging from the ban of crypto-assets to a fully-fledged regulatory framing of the sector, the authorities in different jurisdictions have so far adopted very different approaches. A common element is that financial regulation – both at the level of global standards and single jurisdictions seems to move faster than private law, importantly including companies and securities law.
This is necessary to start deploying a safety net protecting market integrity, customer rights, micro and macro-prudential financial stability, and monetary sovereignty. Italy’s central bank has also called for countries to cooperate and establish an international regulatory framework because the technology operates irrespective of nation-state borders.