The world’s financial stability could be harmed by the fragmented and inconsistent regulation of digital assets, G20’s risk watchdog warned last Thursday.
The Financial Stability Board (FSB), which was founded after the 2008 global financial crisis, has been encouraging countries to bring crypto in line with the traditional financial sector. In 2023, the body issued recommendations on rules, but it is now sounding the alarm after only a few countries followed through with implementation.
In its review, FSB said that “progress has been slow as relatively few jurisdictions have established a comprehensive regulatory framework.”
The financial oversight body was assessing the progress on implementing its crypto rule recommendation in 29 countries, including the U.S, E.U., Hong Kong, and the U.K.
The watchdog added that many crypto firms are taking advantage of the lack of consistent implementation of regulations to engage in regulatory arbitrage.
“Uneven implementation creates opportunities for regulatory arbitrage and complicates oversight of the inherently global and evolving crypto-asset market,” the watchdog cautioned.
With the worldwide crypto market estimated to have roughly doubled to nearly A$5.8 trillion over the past year, and stablecoins hovering around A$488 billion, the watchdog says the time to act is now.
FSB Flags Uneven Rules and Rising Risks
While many countries do have a regulatory framework for digital assets, the FSB review found that their alignment with its recommendations is far from uniform. “This is consequential,” remarked FSB Secretary-General John Schindler in a Reuters interview. “These crypto assets can move across borders very easily, much more easily than other financial assets.”
The concern for the FSB is that crypto asset service providers (CASPs), stablecoin issuers and digital platforms mainly operate across borders, yet national regulatory frameworks remain fragmented. The body pointed to data privacy as one of the reasons why this continues to be the case.
“Secrecy or data privacy laws may pose significant barriers to cooperation,” the FSB wrote in its report, adding that some countries prohibit local crypto firms from sharing data with foreign regulators.
The FSB argues that different approaches to licensing, data sharing, supervision, and enforcement are not reducing risks but rather increasing them.
Markets Safe for Now, But Risks Are Rising
The FSB states that overall risks to global financial stability from crypto assets are “limited at present”, but the warning is far from benign.
The market’s expansion, the increasing integration into mainstream finance, and question marks about custody all point to potential trouble. Consequently, the watchdog is calling for authorities to continue monitoring risks. One of the key recommendations by the FSB is for jurisdictions to identify and monitor “interconnectedness within the crypto ecosystem” and between the crypto world and traditional finance.
As the stablecoin market continues to grow, and with the big players now handling billions, FSB says a shock in one country could ripple worldwide. “The absence of adequate crisis management tools could result in the spillover of shocks from stablecoin arrangements to the traditional financial sector,” FSB writes in its report.
Stablecoins in the Spotlight
A lot of the FSB’s regulatory concerns are directed toward stablecoins. The market for stablecoins has grown by almost 75 per cent, and the trend is expected to continue. In an October letter to G20 Finance Ministers and Central Bank Governors, FSB chair Andrew Bailey warned that vulnerabilities in the stablecoin market “could amplify and introduce new risks to financial stability.”
While many countries now regulate crypto-asset activities to some degree, most lack an effective framework for stablecoins. However, some Western countries seem to be waking up to the problems posed by widespread use of unregulated stablecoins. Australia has passed a stablecoin framework that has seen the first fully licensed AUD-denominated stablecoin hit the market.
Europe is in the process of implementing the Markets in Crypto Assets Regulation (MiCA), which covers stablecoin issuers. The European Commission has also given ESMA increased authority to centralise supervision and prevent regulatory arbitrage through countries like Malta that have weak custody, transparency, and licensing requirements.
In the US, President Trump signed the Genius Act into law, bringing much-needed transparency and consumer protection to the US stablecoin industry.
Due to the ongoing compliance requirements, some stablecoin issuers like Tether have chosen to exit specific markets that don’t fit their mode of operation. The company closed its European operations after MiCA, which requires issuers to back up stablecoins with cash held in a European bank, became law.
If FSB succeeds in its push for closer cooperation on crypto regulations, stablecoin firms operating in multiple countries or processing large cross-border transactions will have no option but to work towards compliance in various jurisdictions.
FSB Piles Pressure on National Regulators
The G20’s regulatory agenda now officially calls on national regulators to strengthen oversight of crypto-asset service providers and coordinate at a global level.
“We can all put in place frameworks, but if there are people who are not cooperating and helping each other, it’s just going to be really challenging because these things just they don’t observe borders,” Schindler said in the interview.
While several countries are showing a willingness to coordinate on regulating stablecoins, countries that are currently benefiting from crypto-friendly policies are reluctant. The FSB specifically mentioned El Salvador, which is home to Tether, the world’s largest stablecoin, noting that it did not participate in the review.
Besides cooperation, the body is calling for transparency when it comes to licensing. Additionally, the G20 watchdog is asking regulators to strengthen their cross-border data-exchange frameworks, standardised oversight tools, and improved disclosures.
What’s Next?
The FSB says many jurisdictions in their review are planning to implement their recommendations in the coming months. The timeline feels tight, but if it were to become a reality, it could spell the end of regulatory arbitrage and finally put a nail in the coffin of the systemic vulnerabilities that were all laid bare to the world with the collapse of FTX and TerraUSD.
