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

A bank risk manager is asked why supervisors worry about interconnections between unbacked crypto markets and the traditional financial system, even though crypto is still small relative to global assets. Which is the best answer?

Even if crypto is small today, rising links through bank and fund exposures and leverage could transmit price shocks into the wider financial system. Regulators therefore act pre-emptively, before risks grow large enough to be systemic.

  1. AGrowth in exposures through banks, funds and leverage could transmit crypto price shocks to the wider system, so risks may grow before they become systemicCorrect
  2. BCrypto markets are too small to ever matter, so supervisors worry only about taxation
  3. CCrypto is risk-free for banks because it has no counterparty
  4. DInterconnections reduce contagion by diversifying every portfolio

Explanation

Supervisors look at potential transmission channels such as leverage, institutional exposures and retail wealth effects. Acting early is prudent because size is small now but could grow rapidly. The other options misstate the risk.

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