Lael Brainard: Crypto-assets and decentralized finance through a financial stability lens

Speech by Ms Lael Brainard, Member of the Board of Governors of the Federal Reserve System, at the Bank of England Conference, London, 8 July 2022.

The views expressed in this speech are those of the speaker and not the view of the BIS.

Recent volatility has exposed serious vulnerabilities in the crypto financial system. While touted as a fundamental break from traditional finance, the crypto financial system turns out to be susceptible to the same risks that are all too familiar from traditional finance, such as leverage, settlement, opacity, and maturity and liquidity transformation. As we work to future-proof our financial stability agenda, it is important to ensure the regulatory perimeter encompasses crypto finance.

Distinguishing Responsible Innovation from Regulatory Evasion
New technology often holds the promise of increasing competition in the financial system, reducing transaction costs and settlement times, and channeling investment to productive new uses. But early on, new products and platforms are often fraught with risks, including fraud and manipulation, and it is important and sometimes difficult to distinguish between hype and value. If past innovation cycles are any guide, in order for distributed ledgers, smart contracts, programmability, and digital assets to fulfill their potential to bring competition, efficiency, and speed, it will be essential to address the basic risks that beset all forms of finance. These risks include runs, fire sales, deleveraging, interconnectedness, and contagion, along with fraud, manipulation, and evasion. In addition, it is important to be on the lookout for the possibility of new forms of risks, since many of the technological innovations underpinning the crypto ecosystem are relatively novel.