The Central Bank of Ireland (“CBI”) published its Securities Markets Risk Outlook Report on 8 February 2022 detailing the CBI' supervisory priorities for securities markets for the year ahead. One element of the report describes how the CBI will retain a cautious stance towards crypto-assets, and indeed funds offering exposure to crypto-assets, in the year ahead. The CBI’s stance remains steadfast despite the greater investor demand, the increasing adoption of crypto-assets generally and what appear to be the less restrictive approaches of other regulators.
After considering the points about crypto-assets raised in the report, this Insight examines how the crypto-asset class is developing and the extent of its adoption by investors, corporations, and lawmakers. Crypto-asset regulatory developments will also be examined in brief.
How such trends will affect the crypto-asset industry is difficult to predict. However, the potential effect of an increase in crypto-asset supervision, greater focus on consumer protection, as well as the development and adoption of the crypto-assets generally might suggest a shift in regulatory attitudes towards crypto-assets in the not-so-distant future.
Recent CBI comments on crypto assets and crypto-asset funds
The Securities Markets Risk Outlook Report identifies the growth of crypto-assets as a development in the securities market that should be considered “highly risky and speculative”. It states that consumers should remain alert to the high risks of buying and holding crypto-assets, including the possibility of losing one’s entire initial investment. The report also emphasises that the majority of crypto-assets remain unregulated in the EU. As a result, crypto-asset investors cannot benefit from the recourse mechanisms, guarantees and/or other safeguards associated with regulated financial services.
Such warnings were also echoed in a recent warning issued by the CBI, as part of a European-wide campaign by the European Supervisory Authorities on 22 March 2022. This publication however also emphasised the increase of misleading crypto-asset advertisements targeting consumers, especially on social media.
The CBI’s attitude towards funds with crypto-asset exposure, as described in the Securities Markets Risk Outlook Report, not surprisingly, all but replicates its cautious stance toward crypto-assets. The report reiterates the CBI’s stance on the approval of funds with exposure to crypto-assets, as examined in a previous Insight here. The CBI maintains that it is extremely difficult for retail investors to assess the risks associated with crypto-assets.
Interestingly the Securities Markets Risk Outlook Report describes how the CBI has seen an increase in queries as to whether UCITS or authorised AIFs may be invested, either directly or indirectly, in crypto-assets – a possible sign of the increasing investor appetite for exposure to crypto-assets via traditional investment vehicles.
Adoption and clarification of the crypto-asset class
One of the issues regulators cite when discussing crypto-assets is the uncertainty that surrounds the crypto-asset class in respect of categorisation. There are over 17,000 different crypto-assets according to the ESAs recent warning, issued by the CBI, and the vast majority of these are unregulated. It is easy to see how the task of categorising such digital assets, often using varying underlying technologies, can pose problems for regulators.
Around the time of the release of the CBI’s report, the CBI’s Director of Securities and Markets Supervision (Patricia Dunne) outlined that there are still a lot of questions around what the essence of a cryptocurrency really is. This is an interesting theme explored by others within the crypto industry where there is a growing consciousness that the language used within the industry is erecting barriers and inhibiting a greater understanding of the assets class. Patricia Dunne questioned whether crypto-assets were an asset or a commodity. She indicated that while those questions remained, the position of the CBI is unlikely to shift from their more cautious stance.
In light of this, despite the large valuations associated with crypto-assets today, it is hard to argue against the fact that crypto-assets are still fundamentally a fledgeling asset class. It is easy to forget that bitcoin itself was only launched around 13 years ago. Therefore the often-cautious approach regulators take to the crypto-industry and related financial assets is perhaps unsurprising.
However, it is hard to deny that the crypto-asset class is progressively snaking towards increased credibility and mainstream adoption. Stripe recently announced its return to crypto-payment processing while Visa ‘s crypto-linked debit card recently hit $2.5 billion worth of transactions in one quarter. Around the world, regions have adopted or have taken steps toward adopting crypto-assets as legal tender (e.g. El Salvador, Lugano, Arizona); and this has all occurred during a time of volatility in the crypto market.
Furthermore, alongside such adoption is the progression of crypto-asset regulation around the world. President Biden recently signed an executive order titled ‘Ensuring Responsible Development of Digital Assets’, bringing crypto-assets one step closer towards financial asset legitimacy in the U.S.
Meanwhile in Europe, on 14 March 2022, the Economic and Monetary Affairs Committee of the EU Parliament (ECON) voted to adopt a draft report on the Markets in Crypto-Asset Regulation (“MiCA”) – a regulation aiming to harmonise regulations for crypto-assets throughout the EU.
The European Parliament in contrast to the CBI is in favour of encouraging crypto assets once they do not propose a risk to financial stability, transparency or market integrity.
MiCA is on course to be the first large-scale and mainstream regulatory regime that aims to govern and regulate crypto-asset issuers and service providers in the world. Once implemented, the proposed Regulation will provide greater clarity in respect of the categorisation of cryptocurrencies as an asset class, dividing the crypto-asset class into subsections. This greater regulatory clarity as to the categorisation of crypto-assets could potentially influence the attitudes of regulators towards approving financial products offering exposure to crypto-assets.
The CBI’s stance: Funds with indirect exposure to crypto-assets
The CBI’s report includes mention of being reluctant to approve funds even with indirect exposure to crypto-assets. While it remains to be seen what interpretation of indirect exposure to crypto-assets the CBI might adopt, funds in other jurisdictions have been approved offering what appears to be indirect exposure to crypto-assets. This is effectively done by a fund offering exposure to equities with high correlations to crypto-assets. Crypto-asset enthusiasts and investors might ask themselves why a fund offering indirect exposure to crypto-assets is not acceptable to the CBI, when the very crypto-asset-correlated equities comprising such funds can be easily accessed? Regardless, the approval of such funds elsewhere in Europe seems to be evidence of the contrast between the CBI’s cautious stance towards crypto-asset funds and that of other financial regulators.
The Volatility of Crypto-Assets
The volatility of crypto-assets is another issue highlighted by regulators and is undoubtedly a feature of crypto-assets. In response to such statements crypto proponents respond that an investor ought to look at the historical appreciation of a crypto-asset and ignore the asset’s short-term volatility. That said, such a risk appetite might not be easy in practice – nor suitable for all types of investors.
One reason for the volatility in crypto-assets is the popularity and widespread use of leverage trading. Leverage trading tools are commonly offered by crypto exchanges and used by crypto traders. Such products also play a significant role in the huge volumes of liquidations that occur during large price movements of crypto-assets.
There are signs however that with increased regulation, exchanges will be forced to restrict the accessibility of such risky products. Already exchanges Binance and FTX have reduced the maximum leverage limits that traders can use – reportedly in response to regulatory scrutiny. In the future, regulators will very likely further restrict access to high leverage in the name of consumer protection – as they have done in equity trading for retail traders. Such developments could assist in reducing the volatility risks associated with crypto-assets as well as protecting retail investors.
With consumer protection at the forefront of its rationale, the CBI’s stance on crypto-assets is perhaps to be expected. Many of the CBI’s statements on crypto-assets echo one other – highlighting that crypto-assets are highly risky, speculative and volatile. In the recent Securities Markets Risk Outlook Report, the CBI re-emphasises the unregulated nature of crypto-assets and their inappropriateness to be the underlying asset from which a fund derives its value – either directly or indirectly, for retail investors. However, as has been discussed, alongside the well-documented increase in adoption and popularity of crypto-assets, as well as the incoming regulatory developments, it may very well be the case that it is merely a matter of time before we begin to see a shift away from the highly cautious attitude of some of the world’s financial regulators to this burgeoning new asset class.