Bitcoin and other digital currencies are still some way off from being a disruptive force in financial markets, says market intelligence group S&P Global – not until they are properly regulated and get more buy-in from the wider market.
In a research note published on Monday, S&P Global financial institutions sector lead, Dr Mohamed Damak said that despite the public interest in cryptocurrencies over the past 12 months, its massive volatility has had, and will continue to have very little impact in the greater scheme of things, until there are regulatory changes.
According to S&P, for now cryptocurrencies remain independent from central banks, but the risk of them infiltrating the traditional financial systems – exposing them to a possible bubble burst – is raising eyebrows among regulators.
The group highlighted four main reasons why Bitcoin and the wider crypto market shows signs of being a bubble:
There are a limited number of ‘coins’. Bitcoin has 16.9 million of the 21 million cap in circulation, and the top 10 cryptocurrencies represent 80% of the current total market cap.
There is extremely high volatility. Over the past 12 months the market value of cryptocurrencies has increased by 33 times – but in the past month has seen billions of dollars’ worth wiped out just as quickly.
There is a high concentration of ‘coins’ in the hands of few users. 1,650 users have more than 1,000 Bitcoin in their portfolios. With no regulation, the market it open to abuse and manipulation.
There is no backing from a credible, central issuer. Thus cryptocurrencies have no intrinsic value, and are driven purely by perception and sentiment.
According to S&P, if cryptocurrencies were to take off and become an effective currency issued in a decentralised manner, the impact on monetary policy implementation would be deep, since central banks might lose their ability to control money supply.
“Conversely, if central banks were to back cryptocurrencies, the central banks would be better positioned to predict money demand and therefore adjust supply accordingly. It is still too early to tell in which direction this instruments will move,” it said.
Because banks have generally steered clear of the crypto craze, should the whole project collapse, financial markets will escape any real damage.
“We expect rated banks to be largely insulated, given that their direct or indirect exposure to cryptocurrencies appears to remain limited,” S&P said, adding that the contribution of cryptocurrencies to global wealth is still very limited.
The global stock market capitalisation reached approximately $80 trillion at year-end 2017, meaning that cryptocurrencies are still a marginal instrument, it said.
“For now, a meaningful drop in cryptocurrencies’ market value would be just a ripple across the financial services industry, still too small to disturb stability or affect the creditworthiness of banks we rate,” Damak said.
“We believe that the characteristics of a cryptocurrency, in its current version, make it more like a speculative instrument that, if its market value were to collapse, would not disrupt global financial stability.”
Should crypto markets collapse completely, retail investors would likely be the first to bear the brunt, it said, as they make up most of the activity in the crypto markets. If cryptocurrencies become an asset class, however, the impact on financial services firms will be more gradual.
“The future success of cryptocurrencies will largely depend on the coordinated approach of global regulators and policymakers to regulate and enhance market participants’ confidence in these instruments,” it said.
“Beyond these immediate impacts, we think that the creation of a cryptocurrency backed by a central bank that gives citizens direct access to this central bank’s ledger is potentially a game-changer to banks as we know them. This does not mean that banks will disappear but it would mean significant changes in the way they do business.”
SARB and crypto currencies
The South African Reserve Bank announced last week that it will be launching a special unit to address regulation in the growing fintech space.
In line with its responsibility to promote a sound and effectively regulated financial system, the SARB said that it has established a Financial Technology (fintech) Programme to strategically assess the emergence of fintech in a structured and organised manner, and to consider its regulatory implications.
SARB said that the main goal of the programme is to track and analyse fintech developments and to assist policymakers in formulating frameworks in response to these emerging innovations.
The fintech programme will focus on three primary objectives:
Regulate cryptocurrencies;
Investigate and decide on the applicability of innovation facilitators;
Experiment with blockchain and distributed ledger technologies.