Top Fed official warns of serious vulnerabilities” in crypto industry

Federal Reserve Vice Chair Lael Brainard said recent crypto volatility has exposed “serious vulnerabilities” in an industry in need of stricter regulation.

Brainard told a Bank of England conference in London on Friday that crypto was not yet "so big or so closely linked to traditional finance" to pose a systemic risk, but raised familiar regulatory concerns.

“Although the crypto financial system is touted as a fundamental break from traditional finance, it is proving vulnerable to the same risks all too familiar from traditional finance, such as leverage, settlement, opacity, and maturity and liquidity transformation,” Brainard said.

“As we work to future-proof our financial stability agenda, it is important to ensure the regulatory perimeter includes crypto finance.”

Crypto markets have come under relentless pressure in recent weeks, with several key players, including crypto hedge fund Three Arrows, collapsing as a result of the markets' plunge. Since the all-time high in November, popular tokens such as Bitcoin and Ether have lost around 70 percent of their value.

In the wake of this market crash, Brainard questioned the often-made arguments for cryptocurrencies like Bitcoin acting as a hedge against inflation.

“Contrary to claims that crypto assets are an inflation hedge or an uncorrelated asset class, crypto assets have declined in value and have proven to be highly correlated with riskier stocks and with risk appetite more generally,” she said.

Brainard's speech also focused on the stablecoin industry, a key factor in the overall health of the crypto market at large. A stablecoin aims to track real-world currencies and provide stability in the crypto market by providing traders a quick way to convert digital tokens into dollars.

“It is critical that stablecoins that purport to be redeemable into fiat currency at par on demand are subject to the types of regulatory requirements that limit the risk of runs,” she added.

Brainard's comments on stablecoins follow the collapse of the once-popular stablecoin TerraUSD and its sister token Luna, a crash that wiped out billions of dollars for investors. Terra relied on computer algorithms and market demand to keep its value constant.

"The Terra crash reminds us how quickly an asset that purports to maintain a stable value relative to fiat currency can go into a run. The Terra crash and the previous failure of several other unbacked algorithmic stablecoins are reminiscent of classic runs throughout history."

Brainard also pointed to Tether – the largest stablecoin in the industry – and the significant outflow pressure the stablecoin provider faced in May. “As the large recent outflow from the largest stablecoin demonstrated, stablecoins pegged to fiat currency are very vulnerable to runs,” she added.

Additionally, Brainard's address targeted cryptocurrency companies that could mirror the activities of traditional finance without equivalent regulatory standards.

She noted that many crypto trading and lending platforms do not have comparable regulation but “also combine activities that need to be separated in traditional financial markets.”

“It is important to address non-compliance and any gaps that may exist,” she said.