Bank of England Points to Risk of Tokenization on Public Blockchains

This week the Bank of England released its Financial Stability Report for December 2023. The Report had several observations regarding the crypto market and associated systemic risks.

Crypto: Not a Systemic Risk… Yet

The report noted that the crypto and stablecoin markets do not yet pose a systemic risk to the wider financial system. In particular, it noted that the size of the crypto market is still relatively small when considered within the wider context and that large-scale institutional adoption has not yet taken place.

However, the Bank of England did highlight some of the risks associated with crypto. The bankruptcies of FTX, Celsius, BlockFi, and Voyager Digital highlighted vulnerabilities in crypto institutions. The impact of these collapses was exacerbated by the fact that centralized crypto exchanges operate as conglomerates – bundling certain functions that would be ring-fenced in traditional financial institutions.

It also said that collapses of algorithmic stablecoin TerraUSD and temporary depegging of major fiat-backed stablecoins (USD Coin, Tether) “reveal risks in existing stablecoin arrangements”.

The Growth of Tokenization on Public Blockchains

The report also highlighted the potential growth of asset tokenization on public blockchains, signaling associated risks such as increased systemic exposure from stablecoins and unbacked crypto assets. It raises concerns about the interconnectedness of markets for crypto and traditional financial assets, emphasizing the need for continued monitoring.

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In terms of institutional adoption of crypto and derivatives, the report acknowledges the current small scale of involvement. However, it points to a potential shift in the landscape, citing an all-time high in the number of contracts for Chicago Mercantile Exchange (CME) bitcoin futures in November 2023. Despite the record high, the notional value of these contracts remains comparatively low at $3.8 billion.