What are FSB’s concerns about crypto asset intermediaries?
- The Financial Stability Board (FSB) recently released a report focusing on crypto-asset intermediaries (MCIs) and their potential risks to global financial stability.
- The report addresses concerns about transparency, governance, concentration risk and potential spillovers into the traditional financial system.
Definition of MCIs
- MCIs are individual firms or affiliated groups offering a range of crypto-based services, primarily centred around operating trading platforms.
- Examples include Binance, Bitfinex and Coinbase.
- In the traditional financial landscape, the functions are provided by separate entities, instead of the same entity.
- This prevents potential conflict of interest and promotes market integrity, investor protection and financial stability.
- MCIs pose structural vulnerabilities due to a lack of controls, operational transparency, disclosures and conflicts of interest.
Revenue Streams and Aspirations
- MCIs primarily generate revenue from transaction fees related to trading activities, including self-issued crypto assets.
- They may also offer additional services like prepaid debit cards and lending.
- Examples include Binance and Coinbase issuing debit cards.
- The report notes that MCIs aspire to become "one-stop shops" for crypto-based services, leveraging economies of scale and scope.
- These MCIs may also derive revenue from operating a blockchain infrastructure for which they may collect transaction validation fees.
- Another source of revenue could be proprietary trading (trading with their own individual capital rather than that of clients, with the aim of acquiring profits).
- FSB’s report observes that the magnitude of these revenue sources is unclear because of the limited publicly disclosed information.
Transparency and Governance Issues
- The report observes that MCIs lack transparency about their corporate structure and are often privately held.
- Even if they disclose information, the report observes, it is typically for a small part of their business, specific to a jurisdiction.
- The report suggests this could be intentional, to limit understanding of their vulnerabilities, economic models and activities evading regulatory oversight.
- Poor risk management may facilitate misconduct and hide risks until negative shocks occur.
- Illiquidity and concentrated holdings coupled with opaque information could allow prices of self-issued crypto assets to be inflated.
Concerns about Binance
- Regulators globally, including the US SEC, expressed concerns about Binance's operations.
- Visa and Mastercard stopped issuing new co-branded cards with Binance.
- SEC Chair accused Binance of an "extensive web of deception" and lack of disclosure.
- Binance was alleged to mislead investors about risk controls and inflate trading volumes.
Concentration Risk
- The report highlights market dominance and concentration as potential vulnerabilities.
- They allow one or more MCIs to become major liquidity sources, leading to incorrect price realization and potential anti-competitive behaviour.
- High concentration may increase entry barriers and costs for users to switch to competitors.
Spillovers into the Traditional Financial System
- While the immediate threat to global financial stability from MCI failure is currently limited, the report acknowledges potential spillovers.
- Recent incidents like Silvergate Bank's winding down after the FTX collapse, revealed concentrated deposit exposures to firms reliant on crypto assets.
- Stress events in crypto-asset markets caused significant losses and shook investor confidence.
Leverage and Liquidity Mismatch
- The report identifies vulnerabilities in leverage and liquidity mismatch within MCIs, particularly concerning assets and liabilities.
- Dependency on formal banks for transaction services exposes MCIs to counterparty and credit risks.
- Especially if the bank fails to provide real-time operations or if the trading venue ceases operations.