Bank of England warns on digital currency risks

The rapid expansion of the unregulated cryptocurrency market will start to pose risks to financial stability, the Bank of England has warned.

The Bank of England in London. It says regulation is needed to manage cryptoasset risks. Picture: Getty Images

The rapid expansion of the unregulated cryptocurrency market will start to pose risks to financial stability as digital assets become intertwined with the wider system, the Bank of England has warned.

The institution told commercial banks and other financial firms to take an “especially cautious and prudent approach” to adopting cryptoassets until regulators around the world have put rules in place to govern them.

The Bank said there was potential for turbulence in traditional financial markets if institutional investors began to take big positions in cryptocurrencies and were then caught out by sharp falls in the price of digital assets.

The warning in the Bank’s latest financial stability report is the strongest yet from Threadneedle Street on the risks posed by the fast-growing market.

Cryptocurrencies exist only as computer code and, unlike traditional forms of money, lie outside the reach of central banks and governments. The most popular digital asset is bitcoin.

Banks and investment firms are increasingly moving into the cryptomarket, despite its high volatility. They include Brevan Howard, one of Britain’s best-known hedge funds, which said in September that it was setting up a division to handle its crypto-investments.

The Bank said that the global cryptomarket had increased tenfold since early last year to stand at about dollars 2.6 trillion last month. It now equates to about 1 per cent of all financial assets. Andrew Bailey, the Bank’s governor, said: “The number is large and growing rapidly.”

Direct risks to Britain’s financial system are “currently limited” but “as these assets become more interconnected with the wider financial system, cryptoassets will present a number of financial stability risks”, the Bank said.

“Stresses in cryptoasset markets could also spill over to broader financial markets,” it added. “For example, if institutional investors embed cryptoassets as a core part of their portfolios, a large fall in cryptoasset valuations may cause investors to sell other financial assets and potentially transmit shocks through the financial system.”

The Bank said that regulation was needed to manage the risks.

There are already signs that the bitcoin market is starting to become correlated with traditional markets. Bitcoin was hit by a sell-off this month, falling by a fifth at one point in a single day. Analysts said the drop may have been exacerbated by falls in stock markets because of worries about Covid-19.

The Times, London