Digital currency exchanges need to be regulated stringently as more mainstream financial institutions enter the industry, the Bank for International Settlements (BIS) has claimed in its latest report.
Titled “Banking in the shadow of Bitcoin? The institutional adoption of cryptocurrencies,” the paper looked at the advent of institutional investment in digital assets and what it means for the future of the nascent industry as well as the banking sector.
The BIS research found that banks had limited exposure to digital currencies so far despite many of them publicly backing digital asset projects. It claims that as of the end of 2020, the average exposure amounted to 0.02% of their risk-weighted assets. This data may have been outdated, however, and since then, more banks have announced digital asset involvement, whether directly through investing in the sector or indirectly by offering digital asset products to their clients.
“We also find that such exposures are primarily in response to growing client interest: the bulk of banks’ exposures relate to trading on client accounts, followed by those due to the clearing of futures,” the report states.
As more big-pocketed investors invade the industry, the role of exchanges must be examined, BIS says. These exchanges have formed a ‘shadow crypto financial system’ after operating for years without any regulation.
The Basel, Switzerland-based institution believes that exchanges have become exactly what digital assets set out to fight—centralized intermediaries.
These exchanges now offer “convenience, market access, transaction scale and liquidity to these markets in much the same manner as in commercial banking and securities trading, albeit without the same degree of regulatory and supervisory oversight.” This underscores the decentralization illusion whereby economic forces that underlie blockchain-based financial applications make centralization inevitable, it says.
This isn’t the first time BIS has called out the lack of true decentralization in the digital asset industry. As CoinGeek reported last year, the institution noted in its December 2021 report that the decentralization that is touted in DeFi applications is illusory. Even in cases where the team steps back, such as in decentralized exchanges or DAOs, blockchain’s consensus mechanism leads to the concentration of decision-making power in a few large coin holders, it said.
The BIS called for regulators to be stringent with exchanges, including through enforcement of KYC programs, consumer protection measures, money-laundering prevention, and risk mitigation measures.
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