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

A regulator observes that crypto markets are interconnected with traditional finance only modestly today, yet argues for regulating now rather than waiting. Which argument best supports acting early?

Early action is justified because growing links to banks, institutions and payment systems could transmit stress to the wider financial system, and rules are harder to introduce after the ecosystem becomes entrenched. Current small size does not remove this future risk.

  1. AGrowing links to banks, institutional investors and payments could allow stress to spread, and rules are harder to impose once the ecosystem is entrenchedCorrect
  2. BBecause crypto is small, regulation has no cost and no effect on innovation
  3. CCrypto assets are legally equivalent to sovereign bonds and so already regulated
  4. DEarly regulation guarantees that crypto prices cannot fall

Explanation

The forward-looking case rests on potential spillovers as linkages grow and on the difficulty of regulating a mature ecosystem. Regulation does not guarantee price stability, crypto is not equivalent to sovereign bonds, and regulation does carry costs.

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