The Basel Committee’s public consultation on the prudential treatment of banks’ crypto asset exposures builds on the proposals in the first consultation issued in June 2021. Unbacked crypto assets and stable coins with ineffective stabilization mechanisms continue to be subject to a conservative prudential treatment, with a new limit proposed on gross exposures. The Committee invites submissions on the proposals in September and aims to finalize the resulting Standard “Prudential treatment of Crypto Assets” around the year-end.

The basic structure of the proposal in the first consultation is maintained, with crypto assets divided into two broad groups: (1) those eligible for treatment under the existing Basel Framework with some modifications, and (2) stable coins with ineffective stabilization mechanisms, which are subject to a new conservative prudential treatment. The updated proposals now provide more detail on the proposed standard and include new elements such as an infrastructure risk add-on to cover the new and evolving risks, adjustments to increase risk sensitivity and an overall gross limit on crypto assets. Given the rapid evolution and volatile nature of the crypto asset market, the committee will continue to closely monitor developments during the consultation period. The Standard that the Committee aims to finalize around year-end may be tightened if shortcomings are identified through the consultation process or if new risk elements emerge during the Committee’s assessment process.

Regulations around the accounting and valuation of payment and security tokens from the perspective of the holder are of critical importance as these tokens are currently the predominant tokens in the investment management industry. These tokens provide (a.o.) token-based authentication, which are scalable and efficient.

Other types of tokens include utility tokens which are linked to a specific use case and are therefore also referred to as a usage token. The ownership of a utility token confers rights that, for example, qualify the holder to purchase a certain product. Hybrid tokens are a combination of a utility, security and/or payment token. Similar to security or utility tokens, a hybrid token can embody certain rights or, like a payment token, be used as a means of payment upon acceptance. The differences are important for potential digital finance packages as investment opportunities in the crypto assets sphere, which are regulated by the market risk framework of crypto assets.

The new Regulatory Framework includes a comprehensive new legislative proposal on crypto-assets, called Markets in Crypto-assets (MiCA), which was developed to help streamline distributed ledger technology and virtual asset regulation in the European Union (EU) whilst protecting users and investors. On 24 September 2020, the European Commission (EC) adopted an expansive new Digital Finance Package that will transform the European economy in the coming decades. The package aims to improve competitiveness of the continent’s Fintech sector and other technologies, while mitigating risk and ensuring the financial stability of the European economy.

A core piece of the regulation will focus on stable coins (coins where a backing mechanism seeks to stabilize confidence and thus value in these coins). Issuers of stable coins will be supervised by the European Banking Authority (EBA). They will have to establish a presence in the EU and build up an adequate minimum liquidity reserve. On a public blockchain such as Ethereum, there is no clear-cut way for the EBA to enforce this, as tokens cannot be effectively regulated on the blockchain itself should, for instance, the token issuer be situated outside of the EU. The critical area where regulation can and must take hold, however, is on the movement between blockchain and the real world. This effectively involves conversion of a stable coin from the blockchain to its underlying real-world asset, such as an EU based fiat currency. Any entity offering this service implicitly requires the client to trust them to perform this movement and, in most cases, for the store of a client’s stable coins as well. This trust is akin the trust required by clients in most business offerings, and especially in banking as an example, which makes effective regulation critically important. Hence, on this layer the EBA can enforce regulations on all entities operating within its jurisdiction. Ultimately, should a blockchain user have the know-how to purchase and transact stable coins that originated outside of the EU, this will be very difficult to regulate. Again, transactions on and off the blockchain can be more easily regulated. As this is likely a minority case, it may not be a top priority to the EBA.

Finally, and under consideration of above, the offering Asset-Referenced Tokens (ARTs) based on a non-European currency will also be regulated. Issuers of ARTs will need to have a registered office in the EU. The legislative aim is to ensure better supervision and monitoring of ARTs. The European Supervisory Authorities (EBA, ESMA and EIOPA – the ESAs) today warn consumers that many crypto-assets are highly risky and speculative.

 Image credits: @quantitatives