The Bank of England (BoE) is again warning about the rapid growth of crypto assets and said that it could pose several financial stability risks to the UK financial system, adding that direct risks are still “limited.”

“It probably isn't a financial stability risk today, but it has all the makings of something that could become one,” BoE Governor Andrew Bailey said after a meeting of the BoE's Financial Policy Committee (FPC).

The central bank’s Financial Policy Committee published a report on Monday that said crypto is becoming more interconnected with the wider financial system; as such, better regulatory and law enforcement frameworks are required to manage risks.

In its December Financial Stability Report, the Committee asked financial institutions to take a “cautious and prudent approach” to crypto adoption until a regulatory regime is in place.

Currently, no major UK banks have reported direct exposure to crypto, but some are starting to offer crypto derivatives trading and customs services, the report noted.

It mentioned that the market capitalization of crypto assets had grown tenfold since early 2020 to now represent about 1% of global financial assets.

But the BoE said 95% of the crypto market is made up of ‘unbacked’ crypto with no underlying assets.

“Such crypto assets have no intrinsic value, are vulnerable to major price corrections, and so investors may lose all their investment,” it said.

While cryptos make up only a small fraction of institutional investors’ portfolios, they have the potential to grow rapidly, it said. A large fall in their valuations then may cause these investors to sell other financial assets, which potentially transmits shocks through the financial system, warned the report adding that the use of leverage amplifies any spillovers.

It is estimated that 2.3 million adults in Britain own crypto, but it only accounts for 0.1% of households' net financial wealth.

The BoE does acknowledge the benefits in terms of reduced frictions and inefficiencies in financial services but said they could only be realized if undertaken safely along with effective public policy frameworks.

The report also said that it welcomes the UK Treasury’s regulatory proposal for “stablecoins” that wants to bring them into the bank’s regulatory remit.

“It takes time to develop regulatory standards,” said BOE Deputy Governor Jon Cunliffe in a press conference. “We’ll need to make sure we have regulation in place before it becomes a problem.”

Last week, the Financial Conduct Authority (FCA) said that investments in crypto assets should not be protected by Britain's Financial Services Compensation Scheme.

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