Bank Outlook 2023: The make-or-break year for digital currencies
Financial institutions and supervisors will be preparing for the crypto and stablecoin regulatory framework next year; it comes into force in 2024. The Eurosystem will also start work on a digital euro payment scheme rulebook, which will assume importance beyond any central bank-issued digital currency
Decrypting the markets in crypto-assets regulation
Just a few weeks ago, the European Council (consisting of EU national government representatives), Parliament and Commission agreed on the “Markets in Crypto-Assets Regulation” (MiCAR). This crypto framework regulates both the issuance of cryptocurrencies and assets, and transactions, e.g. trading, investment and payments. A few things to consider:
- While MiCAR has now been agreed upon at a political level, it is expected to take until 2024 before it actually enters into force. In the meantime, details of regulation have to be worked out in technical standards, and supervisors have to prepare themselves. That said, MiCAR already changes the conversation between financial institutions and supervisors today, as the contours of the future regulatory framework are now clear. This might convince some European banks to press ahead with crypto-related services and experiments ahead of MiCAR actually coming into force, probably in 2024.
- The arrival of MiCAR is certainly positive for the coming of age of the crypto sector, and for banks’ possibilities to engage with crypto. At the same time, any engagement in crypto, by banks or otherwise, is hampered by the fact that a lot of crypto activities are not covered by MiCAR. This applies for example to “decentralised finance” (DeFi), the attempt to replicate financial services on a blockchain infrastructure, without traditional intermediaries. DeFi may have looked and behaved a bit like a casino so far, but it has potentially promising applications as an additional financing channel next to the bank and market finance channels available today. But proper DeFi regulation will have to wait until MiCAR v2.0.
- While attempts were made in the European Parliament to restrict the energy-intensive “Proof of Work” transaction validation mechanism (used by e.g. bitcoin), MiCAR in its final form does not contain any restrictions, but only sustainability disclosure requirements. Meanwhile, the world’s second most important blockchain Ethereum has switched to PoS, a much less energy-hungry mechanism. As a result, developing services around Ethereum will save financial institutions from difficult discussions with policymakers, regulators and the wider public, compared to Bitcoin-related services.
- Insofar as the provision of crypto services by banks would involve taking them onto balance sheets, the prudential treatment matters. This is not part of MiCAR, but is currently under consideration by the Basel Committee for Banking Supervision. The direction of travel is that tokenised traditional assets and selected, really stable, stablecoins would fall under existing prudential rules, though with an additional charge for “infrastructure risk”. But most crypto assets, given their risks and volatility, would in essence need to be backed one-on-one with capital. This would make it very costly to hold such assets. Moreover, the Committee has proposed that crypto assets' total exposure should be limited to 1% of capital.
From a regulatory perspective, the approval of MiCAR means the clearance of an important hurdle. Prudential treatment of crypto has not yet been codified, but the thinking in Basel provides guidance to supervisors. Meanwhile, the “crypto winter” which set in this year may have made the business case to engage in crypto less obvious. Yet some financial institutions may look through current price developments and instead consider the long-term possibilities of crypto and decentralised finance.
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