The Basel Framework and Cryptoassets: Finishing Line? (August 2022)

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Foreword: METI Advisory wrote this report for SEBA Bank AG.
By issuing its second consultative document on the prudential treatment of cryptoasset exposures, and proposing standard text for inclusion in the Basel Framework, the Basel Committee on Banking Supervision (BCBS) has approached the finishing line of its effort started in 2019 to include cryptoasset exposures in the global prudential regulatory framework applicable to banks.

The thinking of the BCBS has evolved over time, from (1) the early identification of a high-risk category of unbacked cryptoassets to be charged with the highest possible capital charge, to (2) a comprehensive framework characterised by

(i) the distinction between four groups of cryptoassets\ A. tokenised traditional assets;\ B. non-algorithmic stablecoins; other cryptoassets;\ C. meeting hedging criteria;\ D. not meeting hedging criteria),

(ii) qualifying conditions for each category,

(iii) dedicated methodologies for calculating regulatory capital charges for market and credit risks for each category,

(iv) the application of the harshest possible capital charge for exposures to cryptoassets C and D,

(v) an approach to calculate the operational risk charge,

(vi) the introduction of an infrastructure add-on for cryptoassets A and B,

(vii) the introduction of an exposure limit for cryptoassets C and D,

(viii) the possibility for supervisors to implement specific add-ons,

(ix) the inclusion of cryptoasset exposures in the leverage ratio, liquidity ratios, and large exposure frameworks,

(x) the limited recognition of cryptoasset A as high-quality liquid assets, and

(xi) detailed disclosure guidance.

On balance, over time, the complexity of the regulatory framework has increased and has become more conservative. Some of the infrastructural/operational conservatism (see vi–viii above) may be gradually relaxed after enhanced confidence is gained over the distributed ledger technology. The attribution of the harshest possible capital charge to cryptoassets C and D needs further work, as it mixes different cryptoassets such as, unbacked layer 1/layer 2 cryptoassets and algorithmic stablecoins.

First, the BCBS should appreciate that the value of cryptoassets comes from the value of the protocol they carry – evidenced by its usage. Currently, the BCBS attributes the highest risk to ‘unbacked’ cryptoassets such as bitcoin and ether because it cannot identify an underlying traditional asset from which to derive a risk profile (let alone a (central) counterparty or intermediary). Second, and consequently, the BCBS should distinguish between unbacked cryptoassets and algorithmic stablecoins.