Excerpts from speech by Timothy Lane, deputy governor, Bank of Canada, Haskayne School of Business, University of Calgary, October 1, 2018
The newness of crypto products and the fact that they claim to be delivering some of the same services provided by regulated financial institutions raises key questions. What risks could they pose? Should they be regulated? If so, how?
The Bank of Canada is not responsible for regulating crypto products. Nonetheless, we have been examining their potential impact on the stability of Canada’s financial system. We’ve also been participating in international research on them, through the Financial Stability Board (FSB), G20 and G7.
Regulators need to examine cryptoassets from a number of angles:
• the potential risks to the stability of the financial system,
• the integrity of markets and protection of investors, and
• protection against abusive financial flows such as money laundering and terrorist financing.
The consensus of policy-makers is that crypto products do not yet pose financial stability risks. This is in part because, despite their rapid growth, crypto products have a relatively small footprint in the financial system. The market capitalization of all crypto assets was recently estimated at $230 billion and the volume of trading in these products at about $15 billion annually.
While these seem like big numbers, they are dwarfed by other global financial markets: global equity markets alone have a market capitalization of around $100 trillion. Moreover, crypto products are not deeply interconnected with the mainstream financial system. For example, there is little evidence that commercial banks are investing in crypto assets or accepting them as collateral.
In this context, the immediate priorities are to address the other two issues I mentioned: investor protection and abusive financial flows. In these areas, the relevant regulators are working hard to adapt their frameworks to cover these new products.
But things are evolving rapidly. Crypto assets are growing in size, complexity and interconnectedness. As the underlying technologies and the design of crypto products evolve, we need to be ready to reassess how they might affect financial stability. Some potential aspects include the integrity of payment systems, bank business models, and the exposures of financial institutions and infrastructures. The FSB and related bodies are monitoring this evolution closely.
In such cases the crypto exchange holds the only copy of the key to the client’s crypto assets. The crypto assets are thus accessible only to the exchange; the investor holds a claim on the exchange.
Regulators also have to be forward-thinking about what kind of action may be required. That means putting in place a framework that is sufficiently adaptable so when new products emerge that potentially pose new risks, regulatory agencies will be ready.
Crypto products are already regulated in many countries at the national or regional level. But in many jurisdictions the regulatory framework is far from complete. Also, given that crypto assets are global in scope and not confined by borders, an emerging problem is the gaps between regulatory regimes.
Different jurisdictions have adopted different regulatory approaches, depending on how they have defined these assets. When a new product is launched, is it classified as a payment instrument, a security, a commodity or none of the above? Should crypto exchanges be called banks, financial market infrastructures or something else? These classifications differ across jurisdictions and in some cases remain nebulous.
Beyond these differences in classification, the regulatory treatment of these assets differs. In China, the response has been to ban them. In Japan, authorities are creating a framework to manage the risks associated with their growth. Such differences among regulations globally, together with the incompleteness of regulation in many jurisdictions, open room for promoters to engage in regulatory arbitrage, developing new products to exploit them.
Regulators must decide how far they need to go in harmonizing their approaches with other countries. Differences in the regulatory treatment of these products for controlling money laundering and terrorist financing are a particularly pressing concern.
Such factors pose key challenges for regulatory agencies. Data and a consistent means of collecting them are required to assess emerging risks. And an agreed system is needed to classify new products by their attributes and economic functions.
At the same time, we need to avoid regulation that is so heavy-handed or cumbersome that it stifles innovation. New crypto products could deliver more of what the public wants and bring more competition and financial inclusion to the system. Developments in this space could spur the growth of technologies that have important positive spinoffs. These concerns must be carefully balanced.
The regulatory framework in Canada is still a work in progress, but a number of steps have been taken by the federal and provincial governments, which share jurisdiction in this area.
In 2014, the federal government amended Canada’s anti-money laundering legislation to include businesses dealing in crypto assets. Regulations based on the legislation are now being finalized. The Canada Revenue Agency also published a note on the tax laws that apply to crypto assets. And the Financial Consumer Agency of Canada has a useful backgrounder on the risks and tips for using cryptoassets.
At the provincial level, the Canadian Securities Administrators issued a staff notice in 2017 on crypto offerings, warning investors about issues such as volatility, transparency, valuation, custody and liquidity, as well as the use of unregulated cryptocurrency exchanges. The notice also offers guidance on the applicability of securities laws and what steps businesses should take if they are raising capital through ICOs.
Central bank digital currency
At the Bank of Canada, we are also considering the potential implications of these developments for our own core functions. In particular, we are assessing how we could respond if crypto assets were to evolve in a way that undermines our ability to provide Canadians with a means of payment with stable purchasing power that they can use with confidence.
This is related to our ability to implement effective monetary policy as well as to the security and finality of settlement we provide through our bank notes. While we do not have any doubts currently about our ability to fulfill our mandate, contingency planning is important: the changes driven by technology may be rapid.
In this context, one of our priorities is to explore under what conditions, if any, we might recommend to the government that we issue our own digital currency. At the same time, we are studying key design questions related to a central bank digital currency (CBDC), such as what form it might take and whether it would be anonymous like cash. As it turns out, the questions of “under what conditions” and “in what form” are closely intertwined.
The design of a CBDC has important implications for its risks and benefits. For example, some major reasons for caution about a central bank digital currency are concerns that it could become a vehicle for illicit transactions or that it could have significant negative implications for financial intermediation. Unless such risks could be managed through appropriate design, the Bank would not recommend issuing such a currency.
Ultimately, then, this exploration is going to require a unique combination of economics, technology and business strategy as well as thorough consultations with all stakeholders. We have assembled a multidisciplinary team to do this work and will provide more details as the research unfolds. We are also exchanging information with other central banks, notably the Swedish Riksbank, which is well along in examining CBDCs.