On 10 June 2021, the Basel Committee on Banking Supervision (BCBS) published a preliminary proposed framework for the prudential treatment of cryptoasset exposures based on classification cryptoassets (the Proposal).1 Under the Proposal, banks would be subject to risk-weighted capital and liquidity and on-going monitoring requirements for cryptoassets held on their balance sheets. Specifically, the Proposal seeks to map the regulatory capital requirements for cryptoassets that are redeemable into physical assets to the treatment of those assets and to the exposure to any counterparties whose performance is required to effectuate such redemption. The Proposal would impose larger capital requirements on cryptoassets (such as Bitcoin) that neither represent nor are redeemable into underlying physical assets, as well as funds or other entities that derive their value from such other cryptoassets. Comments are due by 10 September 2021.
The Proposal marks an important milestone in central banks’ efforts to recognize and account for the potential financial stability risks posed by cryptoassets. It is of importance not only to banks but also to managers of funds and other assets that may be marketed as investments to banks. This Article will describe the basic capital adequacy framework for cryptoassets and discuss the basis for calculating the risk-weighted asset value (RWA) of tokenized assets, stabilized coins and other cryptoassets. It also will cover some compliance issues for banks, their supervisors, and others who might be affected by prudential capital requirements of banks. It is part of a growing concern with the potential financial stability implications of cryptoassets.2
OVERVIEW OF THE PRUDENTIAL TREATMENT OF CRYPTOASSET EXPOSURES
The Proposal is agnostic as to the particular technical attributes of any cryptoasset, as the BCBS recognizes that it is not feasible to predict or prescribe how technology and any specific cryptoasset will evolve. Rather, it has proposed a principles-based approach under which the prudential treatment of cryptoassets would be guided by the following considerations:
Same Risk, Same Activity, Same Treatment: Regulatory capital requirements should be “technology neutral” so that equivalent economic functions and risks are the same, whether presented by a cryptoasset or a “traditional asset.” However, the prudential treatment should also account for any additional risks posed by cryptoassets.
Simplicity: Since cryptoassets are currently a small asset class for banks, the prudential framework should focus on simplicity and should be revisited as the cryptoasset markets evolve.
Minimum Standards: While BCBS’ guidelines are meant to be a minimum standard for internationally-active banks, jurisdictions may adopt more conservative measures, including prohibiting their banks from having any exposures to cryptoassets.
Under the Proposal, cryptoassets are divided into two broad groups. Group 1 cryptoassets consist of tokenized assets and stabilized tokens that are linked to particular underlying assets (such as US dollars or gold) and are therefore susceptible of risk-based capital treatment that is based on the risk weight of underlying assets and counterparties. All cryptoassets that do not fit within Group 1 (generally those that are not linked to any underlying assets) are classified into Group 2 and are subject to a more punitive risk weighted capital treatment. Group 2 cryptoassets would include, for example, Bitcoin, Ether, Litecoin, and Dogecoin.
Classification into Group 1 requires that four conditions are met on an ongoing basis:
Condition 1. The cryptoasset must either be a tokenized traditional asset (Group 1a), or must have an effective stabilization mechanism that references the cryptoasset’s value to one or more underlying physical assets, such as dollars or an index of fiat currencies (Group 1b). Stabilization mechanisms that…