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FRM Part II · FRM Exam Part II · Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets

A bank risk committee considers why unbacked crypto assets could transmit stress to the traditional financial system. Which channel is most relevant to their market structure?

Stress can spread through leveraged positions, shared custodians and exchange failures that force fire sales and cause losses at connected institutions. Crypto is not regulatory capital and has no automatic backstop, so interconnections are the key transmission channel.

  1. AInterconnections through leveraged positions, shared custodians and exchange failures that can force fire sales and losses at linked institutionsCorrect
  2. BTheir direct use as Tier 1 capital at systemically important banks
  3. CMandatory central bank backstops for all crypto exchanges
  4. DTheir zero correlation with any other risk asset in all conditions

Explanation

Leverage, concentrated custodians and exchange failures can trigger forced liquidations and counterparty losses that reach regulated institutions. Crypto is not Tier 1 capital, has no automatic central bank backstop, and its correlation with risk assets can rise in stress.

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