The Reserve Bank of India (RBI) has slammed unbacked crypto assets (such as Bitcoin), stablecoins and decentralised finance (DeFi) and crypto asset trading platforms, underscoring the need for regulatory guardrails to ensure financial stability and consumer and investor protection.
In its annual 'Financial Stability Report' (FSR) 2022, India's central bank and regulatory body said that the early ramifications are reflected in the crypto ecosystem with one stablecoin losing almost all its value and another depegging from the US dollar.
It referred to the collapse of TerraUSD and Luna cryptocurrencies that threw many investors into a panic in May. In a crash, the once bullish TerraUSD and sister coin Luna had lost almost all their value, sending shock waves across the world.
"Several vulnerabilities associated with crypto asset markets have been highlighted such as linkages between crypto asset markets and the regulated financial system; liquidity mismatch, credit and operational risks, with the potential spillover to short term funding markets; increased use of leverage in investment strategies; concentration risk of trading platforms; and opacity and lack of regulatory oversight of the sector," the RBI report highlighted.
The International Organisation of Securities Commissions has noted that DeFi is a spectrum and not a 'binary outcome', and that some DeFi products and services may retain a level of centralisation through concentrated ownership of the 'governance tokens', or by restricting the governance decisions for users.
"The risks associated with DeFi include speculative trading, flash loans, cross-border lending and borrowing, front running, cybersecurity, asymmetry and fraud," said the RBI.
This has stressed the need for continuous examination of this evolving landscape and its implications for traditional financial institutions.
"The growing threat of the crypto-assets ecosystem warrants drastic approaches by national authorities," the RBI noted.
Global regulatory efforts continue to focus on risks associated with the crypto ecosystem and the threat of decentralisation.
Stablecoins -- whose value is pegged to another asset like a fiat currency or a commodity -- are bad investments and are ill-suited as a form of money, Siddharth Tiwari, the Asia-Pacific head of the Bank of International Settlements (BIS), said last week.
RBI Governor Shaktikanta Das said that cryptocurrencies are a clear danger to the financial systems, adding that the world must be mindful of the emerging risks on the horizon.
Finance Minister Nirmala Sitharaman has announced that the RBI will roll out the Central Bank Digital Currency (CBDC) in FY23 that will be based on Blockchain technology.