Ownership of cryptoassets is also broadening, primarily as a speculative investment rather than a method of payment. In 2021, about 13% of Canadians owned Bitcoin, up from 5% in 2020. The median holding of Bitcoin was about $500, mostly for investment purposes. To date, the significant volatility in the prices of these unbacked cryptoassets as well as high transaction costs have been key obstacles to their wide acceptance by merchants as a method of payment. For example, prices of cryptoassets such as Bitcoin and Ether were generally four to five times more volatile throughout 2021 than the S&P 500 stock market index was. Sudden price corrections mean that investors who hold these types of cryptoassets can be exposed to significant financial losses.
Interconnections between unbacked cryptoasset markets and the financial system appear limited but 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 readily available and consistent data on the exposures of financial system participants to these markets. Discussions with industry participants suggest that portfolio exposures remain small. Cryptoassets have generally become more accessible to investors in recent years through the emergence of closed-end funds, crypto exchange-traded funds and listed companies dealing in or mining cryptoassets. Moreover, hedge funds and some large pension funds are reportedly investing more in cryptoasset platforms. Cryptoassets are also becoming more integrated into the traditional financial system (often referred to as the financialization of cryptoassets), including through the development of crypto derivatives markets and as investment assets or collateral for loans.
The Bank’s assessment that these markets are not yet of systemic importance is reinforced by the fact that the major sell-off in cryptoasset markets in May 2022 was broadly inconsequential for the traditional financial system in Canada and abroad.
Stablecoins aim to meet the demand for a more liquid and less volatile cryptoasset. Stablecoins play a key role in decentralized finance, a suite of alternative financial products offered in cryptoasset markets that mimic traditional financial services (e.g., loans, insurance, asset management and custody). Like other cryptoassets, stablecoins can also pose risks to financial stability if adopted on a significant scale without appropriate regulatory safeguards, particularly regarding the ability of issuers to respect redemptions (Box 5).
The lack of adequate regulatory frameworks for cryptoassets is a key factor behind this vulnerability. Firms operating in cryptoasset markets often 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 addressed, investors in and end users of unbacked cryptoassets are subject to heightened risk of financial losses from events such as fraud, cyber attacks or the failure of a key custodian or service provider. Moreover, a significant challenge to the regulation of cryptoassets is that they are easily used for transactions across borders. This can be positive for economic activities such as remittances, but it creates opportunities for illegal transactions such as money laundering and terrorist financing. For the regulation of these markets to be effective, countries will have to coordinate closely to ensure consistency and prevent criminals from exploiting regulatory gaps.
The regulatory response is taking form but needs to gather momentum. Regulators globally have recognized the risks posed by deficient regulatory frameworks and are working to address them. For instance, in March 2022 the US administration released an expansive executive order:
- launching a strategy on digital assets
- requesting many federal government agencies to jointly examine the regulation of digital assets
In Canada, provincial securities administrators have issued guidance for the regulation of cryptoassets and cryptoasset trading platforms that meet the definition of securities or securities market infrastructure, 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 cryptoassets and stablecoins. As part of that 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 currently chairs the FSB Regulatory Issues of Stablecoins working group that is collaborating to promote globally coordinated regulatory responses to stablecoins.
More generally, federal and provincial authorities should move quickly to develop an integrated regulatory regime for cryptoassets, otherwise this vulnerability could continue to worsen.