Digital Securities as a New Systemic Risk in the Economy

The emergence of digital securities has sparked debate regarding their potential to introduce new systemic risks into the global economy. Systemic risk, in essence, refers to the possibility of a single event within a company or sector triggering widespread instability or collapse throughout the entire financial system.

Contradictory Views on Systemic Risk

Regulatory bodies hold varying perspectives on the systemic risk posed by digital securities:

• European Securities and Market Authority (ESMA) and the Federal Reserve (USA): Currently, these institutions do not perceive digital securities as a significant systemic risk.
• Reserve Bank of India (RBI) and Bank of England: These institutions express concerns about the potential for future systemic risks if digital securities are not adequately managed.

Factors Contributing to Systemic Risk

Several factors contribute to the potential for digital securities to introduce systemic risks:

• High Volatility: The digital asset space is characterized by extreme price volatility, making it susceptible to rapid and unpredictable fluctuations.
• Collapse of Speculative Schemes: The collapse of speculative digital asset projects can trigger cascading effects, leading to widespread losses and market instability.
• Mismanagement and Governance Issues: Poor governance and mismanagement within digital asset platforms can undermine investor confidence and lead to systemic failures.
• Cyber-Attacks: Cyber-attacks targeting digital asset exchanges and wallets can result in significant financial losses and erode trust in the system.
• Interconnectedness with Traditional Financial Markets: The growing interconnectedness between digital asset markets and traditional financial markets increases the potential for contagion, where problems in one market can spill over into the other.
• Case Studies:
  • The collapse of the digital asset exchange FTX.
  • The de-pegging of TerraUSD from the US dollar in May 2022, which led to the downfall of LUNA and other stablecoins. These events highlight the potential for rapid and devastating market crashes.

Regulatory Importance

• Proper regulations are crucial for mitigating the systemic risks associated with digital securities.
• Clear and consistent regulatory frameworks are needed to address issues such as:
  • Investor protection
  • Market integrity
  • Cybersecurity
  • Anti-money laundering (AML) and counter-terrorist financing (CTF)
  • Systemic risk monitoring.