Ownership of cryptocurrencies is also expanding, primarily as a speculative investment rather than as a method of payment. In 2021, about 13% of Canadians owned Bitcoin, compared to 5% in 2020. The average share of Bitcoin was about $ 500, mostly for investment purposes. To date, the significant price volatility of these unsupported cryptocurrencies, as well as the high transaction costs, have been key obstacles to their widespread acceptance by merchants as a payment method. For example, the prices of cryptocurrencies such as Bitcoin and Ether were generally four to five times more volatile in 2021 than the S&P 500 stock index. Sudden price corrections mean that investors who own such cryptocurrencies may be exposed. to significant financial losses.
The interconnections between unsupported cryptocurrency markets and the financial system seem limited, but they are expanding rapidly. Institutional participation in these markets has grown in recent years. However, estimating the growth of institutional investments in these assets and related infrastructure is difficult due to the lack of available and consistent data on the exposure of financial system participants to these markets. Discussions with industry participants suggest that portfolio exposures continue to be declining. In general, cryptocurrencies have become more accessible to investors in recent years thanks to the emergence of closed-end funds, cryptocurrency exchanges, and listed companies that trade or mine cryptocurrencies. In addition, hedge funds and some large pension funds are investing more in cryptocurrency platforms. Cryptocurrencies are also increasingly integrated into the traditional financial system (often known as cryptocurrency financing), including through the development of cryptocurrency derivatives markets and as investment assets or collateral for loans.
The Bank’s assessment that these markets are not yet systemically important is reinforced by the fact that significant sales in the cryptocurrency markets in May 2022 were generally insignificant to the traditional financial system in Canada and abroad.
Stablecoins aim to meet the demand for a more liquid and less volatile cryptocurrency. Stable currencies play a key role in decentralized finance, a set of alternative financial products offered in cryptocurrency markets that mimic traditional financial services (e.g., lending, insurance, asset management, and custody). Like other cryptocurrencies, stable currencies can also pose risks to financial stability if they are adopted on a significant scale without adequate regulatory safeguards, especially with regard to the ability of issuers to meet repayments (Table 5).
The lack of appropriate regulatory frameworks for cryptocurrencies is a key factor behind this vulnerability. Companies operating in the cryptocurrency markets typically perform functions similar to those of traditional financial institutions. They share many risks but are not subject to the same regulatory standards. Until this regulatory gap is resolved, investors and end users of unsecured cryptocurrencies are at increased risk of financial loss from events such as fraud, cyberattacks, or the failure of a key custodian or service provider. In addition, a major challenge for the regulation of cryptocurrencies is that they are easily used for cross-border transactions. This can be positive for economic activities such as remittances, but it does create opportunities for illegal transactions such as money laundering and terrorist financing. For the regulation of these markets to be effective, countries will need to coordinate closely to ensure consistency and prevent criminals from taking advantage of regulatory loopholes.
The regulatory response is taking shape, but it needs to gain momentum. Regulators worldwide have recognized the risks posed by poor regulatory frameworks and are working to address them. For example, in March 2022, the US administration issued an expansive executive order:
- launch a strategy on digital assets
- asking many federal government agencies to jointly examine the regulation of digital assets
In Canada, provincial securities managers have issued guidelines for the regulation of cryptocurrencies and cryptocurrency trading platforms that meet the definition of securities market infrastructure or securities, respectively. The federal government announced in its 2022 budget that it would conduct a legislative review of the financial sector. The first phase of this review will focus on digital currencies, including cryptocurrencies and stable currencies. As part of this work, the government will examine:
- regulatory approaches to maintaining the security and stability of the financial system as digital currencies become more common
- the potential need for a central bank digital currency in Canada
In addition, a Bank of Canada official is currently chairing the FSB Regulatory Issues of Stablecoins Working Group, which is working to promote coordinated global regulatory responses to stablecoins.
More generally, federal and provincial authorities should make rapid progress in developing an integrated regulatory regime for cryptocurrencies, otherwise this vulnerability could continue to worsen.