Keynote speech by Fabio Panetta, Member of the Executive Board of the ECB, at
the Insight Summit held at the London Business School
London, 7 December 2022
It is a true pleasure to be back at the London Business School.
I did my PhD here many years ago. As soon as I arrived, I found myself immersed in an environment where
pioneering academic research and economic analysis were carried out in a friendly atmosphere. In those years I
learned not only to be rigorous in doing research, but also the importance of doing ones job with enthusiasm.
I still have vivid memories of stimulating and motivating discussions with my fellow students and the faculty. I
am particularly grateful to my PhD supervisor and dear friend, Professor Richard Brealey.
Moving from the past to the future, today I will discuss crypto-assets and the destiny of digital finance.
When I last spoke about crypto finance at Columbia University last April, I likened it to the Wild West and
warned about the risks stemming from irrational exuberance among investors, negative externalities and the lack
Crypto markets have since witnessed a number of painful bankruptcies. The crypto dominos are falling, sending
shockwaves through the entire crypto universe, including stablecoins and decentralised finance (DeFi).
The crash of TerraUSD, then the worlds third-largest stablecoin, and the recent bankruptcy of the leading crypto
exchange FTX and 130 affiliated companies each took only a few days to unfold. This is not just a bubble that is
bursting. It is like froth: multiple bubbles are bursting one after another.
Investors fear of missing out seems to have morphed into a fear of not getting out.
The sell-off is exposing those swimming naked. It has laid
bare some unbelievably poor business and governance practices across a number of crypto firms. It has revealed
that some investors have been acting carelessly by investing blindly without proper due diligence. And similar
to the sub-prime crisis, the crash has uncovered the interconnections and opaque structures within the crypto
house of cards.
This is set to dampen enthusiasm in the belief that technology can free finance from scrutiny. The crash has
served as a cautionary reminder that finance cannot be trustless and stable at the same time.
Trust cannot be replaced by religious faith in an algorithm. It requires transparency, regulatory safeguards and
Does this mean we are witnessing the endgame for crypto? Probably not. People like to gamble. On horse races,
football games and many other events. And some investors will continue to gamble by taking speculative positions
Today I will argue that the fundamental flaws of crypto-assets mean that they can quickly collapse when
irrational exuberance subsides. We should therefore focus on protecting inexperienced investors and preserving
the stability of the financial system.
Ensuring that crypto-assets are subject to adequate regulation and taxation is one path to achieving this. Here,
we need to move rapidly from debate to decision and then implementation.
But even regulation will not be enough to address the shortcomings of cryptos. To harness the possibilities of
digital technologies, we must provide solid foundations for the broader digital finance ecosystem.
This requires a risk-free and dependable digital settlement asset, which only central bank money can provide. And
that is why the ECB is working on a digital euro while also considering new technologies for the future of
wholesale settlement in central bank money.
Fundamental flaws in crypto finance
The philosophy behind cryptos is that digital technology can replace regulated intermediaries and avoid state
intrusion. In other words, that it is possible to build a trustless but stable financial system based
This is just an illusion, as was clear from the outset and confirmed by recent developments. In fact, it is
precisely the absence of regulation and public scrutiny that blinded investors to the risks involved, leading to
the rise and subsequent fall of crypto-assets.
The risks associated with crypto finance stem from three fundamental flaws. I will address each of them in turn.
Unbacked crypto-assets offer no benefits to society
The main structural flaw of unbacked crypto-assets which form the bulk of the crypto market (Chart 1) is
that they do not offer any benefits to society.
Market capitalisation of crypto-assets
Despite consuming a vast amount of human, financial and technological resources, unbacked crypto-assets do not
perform any socially or economically useful function. They are not used for retail or wholesale payments they
are just too volatile and inefficient. They do not fund
consumption or investment. They do not help fuel production. And they play no part in combating climate change.
In fact, unbacked crypto-assets often do the exact opposite: they can cause huge amounts of environmental
damage. They are also widely used for criminal and terrorist
activities, or to evade taxes.
As a form of investment, unbacked crypto-assets lack any intrinsic value. They have no underlying claim: there is
neither an issuer who is accountable and liable, nor are they backed by collateral. They are notional
instruments, created using computing technology, which do not generate financial flows or use value for their holders. Therefore, their value cannot
be estimated from future income discounted to the present, like for real and financial assets.
Unbacked crypto-assets cannot help to diversify portfolios. Recent developments show that their value does not
increase when income becomes more valuable to consumers such as in periods of high inflation or low growth.
Crypto-assets are not digital gold. Their price changes show increasing correlation with stock markets (Chart
2), with much higher volatility. And recent developments highlight their intrinsic instability: the first
bitcoin exchange-traded fund lost more on its price since its launch than any other that has been
Correlation between bitcoin and stock markets
Many investors have suffered significant losses from the crypto collapse and cannot expect any compensation.
There are no insurance schemes. And in several instances, crypto-assets have been shown to offer little
protection against IT and cyber risks.
On the whole, it is difficult to see a justification for the existence of unbacked crypto-assets in the financial
landscape. Their combined features mean that they are just speculative assets. Investors buy them with the sole
objective of selling them on at a higher price. In fact, they are a gamble disguised as an investment asset.
Millions of investors were lured by an illusory narrative of ever-rising crypto-asset prices a narrative that
was fuelled by extensive news reports and investment advice on social media, highlighting past price increases
and features such as artificial scarcity to create the fear of missing out. Many invested without understanding
what they were buying.
Irrational enthusiasm prospered on self-fulfilling expectations: the textbook definition of a bubble. Like in a Ponzi scheme, such dynamics can
only continue so long as a growing number of investors believe that prices will continue to increase. Until the
enthusiasm vanishes and the bubble bursts.
The market value of crypto-assets has shrunk from 2.5 trillion at its peak a year ago to less than
1 trillion today (Chart 1). The price of bitcoin has
fallen by more than 70% from its peak (Chart 3).
Price of bitcoin
Stablecoins are exposed to runs
The second structural flaw is the purported stability of stablecoins, which the entire crypto ecosystem has
relied on to underpin trading in crypto-assets and liquidity provision in DeFi markets.
Although stablecoins represent only a small part of the crypto-asset market, crypto trading using Tether, the largest stablecoin, accounts for close to half
of all trading on crypto-asset trading platforms (Chart 4).
Stablecoin trading volumes and use in crypto trading
Stablecoins appeal to users because it is claimed that, unlike unbacked cryptos, they provide stability by having
their value tied to a portfolio of assets known as reserve assets against which stablecoin holdings can be
redeemed. Algorithmic stablecoins, meanwhile, aim to match
supply and demand to maintain a stable value.
But the recent crypto crash has highlighted that without sound regulation stablecoins are stable in name
Digital innovation cannot, for example, build stable values on the basis of codes and mechanisms of dependency.
This was the key takeaway from the collapse of the algorithmic stablecoin TerraUSD, which lost its peg to the US dollar in May and has since been trading for less
than 10 US cents (Chart 5).
TerraUSDs lost peg
Tether also temporarily lost its peg amid the ensuing market stress. This showed that, even for collateralised stablecoins, risks cannot be
eliminated easily. Without public backing, the risks of contagion and runs are widespread and the
liquidation of part of the reserve assets can have procyclical effects and further reduce the value of the
remaining reserve assets. These risks are magnified when the composition of the reserve assets is concealed.
Overall, this scramble for stability and the shortcomings of stablecoins underscore the importance of a
settlement asset that maintains its value under stressed conditions. In the absence of a risk-free digital
anchor, which only digital central bank money can provide, stablecoins represent an overambitious attempt to
create a risk-free digital asset backed by risky assets.
The third structural weakness is the fact that crypto markets may have incredibly high leverage and
interconnections. This creates strong procyclical effects, given the lack of shock absorption capacity.
Crypto exchanges allow investors to increase exposures by up to 125 times the initial investment (Chart 6, left
panel). As a result, when shocks hit and deleveraging is needed, they are forced to shed assets, putting strong
downward pressure on prices (Chart 6, right panel).
These procyclical effects are exacerbated by the pervasive overcollateralisation adopted in DeFi lending to
compensate for the risks posed by anonymous borrowers.
Moreover, funds borrowed in one instance can be reused as collateral in subsequent transactions, allowing
investors to build large exposures. Shocks can propagate rapidly across collateral chains and are amplified by
positions liquidated automatically using smart contracts.
These are precisely the dynamics we have seen at work in the recent crypto failures, which have sent shockwaves
throughout the crypto universe, including in DeFi markets
used to build leverage.
The inadequate governance of crypto firms has magnified these structural flaws. Insufficient transparency and
disclosure, the lack of investor protection, and weak accounting systems and risk management were blatantly
exposed by the implosion of FTX. Following this event,
crypto-assets may move away from centralised to decentralised exchanges, creating new risks owing to the absence
of a central governance body.
The destiny of digital finance
These fundamental flaws have led many to predict the demise of crypto-assets. But these flaws alone are unlikely
to spell the end of cryptos, which will continue to attract investors looking to gamble.
Gambling is perhaps the second oldest profession in the world. It has been traced back to ancient China, Greece
and Rome. People have always gambled in different ways: casting lots, rolling dice, betting on animals or
playing cards. And in the digital era I expect them to continue gambling by taking speculative positions on
We therefore need to mitigate the risks, while harnessing the innovative potential of digital finance beyond
cryptos. There are two elements to this.
The first is to regulate crypto-assets and ensure that they do not benefit from preferential treatment compared
with other assets.
The recent failures of crypto entities do not seem to have had a material impact on the financial sector. But
they have highlighted the immense potential for economic and social damage if we leave cryptos
unchecked. And the links between the crypto market and the
financial system may become stronger, especially as major tech companies enter the sector.
That is why we now need urgently to regulate crypto-assets. It is crucial that the regulatory frameworks
currently in the legislative process quickly enter into force and start being implemented so that words can be
followed by deeds.
Addressing financial risks
Regulators must walk a tightrope. For one, they need to build guardrails to tackle regulatory gaps and arbitrage.
But they also need to avoid legitimising unsound crypto models and refrain from socialising the risks through
Regulatory efforts should primarily be directed at preventing the use of crypto-assets as a way of circumventing
financial regulation. The principle of same functions, same risks, same rules applies regardless of
technology. This should be coupled with measures to ensure that the risks of crypto-assets are clear to all.
Potential buyers should be fully aware of the risks they take when buying cryptos and the services surrounding
them. Gambling activities should be treated as such.
The other task is to shield the mainstream financial system from crypto risks, notably by segregating any
crypto-related activities of supervised intermediaries.
The EUs Regulation on Markets in Crypto-Assets (MiCA) is leading the way in building a comprehensive regulatory
framework. MiCA will regulate stablecoins, crypto-assets other than stablecoins, and crypto-asset service
providers. It will subject stablecoin issuers of e-money tokens and asset-referenced tokens
to licensing and supervision. And it will regulate the reserve assets backing stablecoins in order to contain
their risks. In turn, the regulation requires that buyers of crypto-assets are informed about the inherent risks
involved. It is crucial that the regulation enters into force as soon as possible.
Looking ahead, the regulation of crypto activities will have to be adapted to the continuous evolution of crypto
risks. Given the time needed to design and apply new legislation, it is important to empower regulators,
overseers and supervisors to adjust their instruments to keep pace with market and technological developments.
The ECB is not responsible for regulating investment activities. But we are responsible for overseeing European
payment systems, and we have already taken action in this field. Our oversight framework for payment
instruments, schemes and arrangements the PISA framework that was launched last year addresses the risks of
stablecoins and other crypto-assets for payment systems.
Since crypto-assets know no borders, their regulatory framework must be global. This requires rapid
implementation of the Financial Stability Boards recommendations to make the regulatory, supervisory and
oversight approaches to crypto activities consistent and comprehensive across different countries. Swift progress is also needed to finalise the Basel
Committee on Banking Supervisions framework for the prudential treatment of banks crypto-asset activities.
Addressing and internalising social risks
Authorities also need to address the significant social costs of crypto-assets, such as tax evasion, illicit
activities and their environmental impact. The use of
crypto-assets for money laundering and terrorist financing could be prevented by applying the standards set by
the Financial Action Task Force.
The other task is to ensure that the taxation of crypto-assets is harmonised across jurisdictions and consistent
with how other instruments are taxed. In Europe, given the
negative externalities that crypto activities can generate across multiple Member States, the EU should
introduce a tax levied on cross-border crypto issuers, investors and service providers. This would generate
revenues that can be used to finance EU public goods that counter the negative effects of crypto-assets.
Such a tax could, for example, address the high energy and environmental costs associated with some crypto-mining
and validation activities. This would be in line with the current EU priorities to address climate change and
ensure energy security. Crypto-assets deemed to have an
excessive ecological footprint should also be banned.
Balancing innovation and stability: an anchor for digital finance
But even regulation would not be enough to provide a stable basis for digital finance. The second factor at play
here is that, in order to harness the opportunities offered by technological innovation, we need to give digital
finance like other forms of finance an anchor of stability in the form of a digital risk-free asset.
Only central bank money can provide an anchor of stability
Some commentators are of the view that adequate regulation would allow stablecoins to provide such a risk-free
asset. This is a misconception.
Stablecoins invest their reserve assets in market instruments, which inevitably exposes them to several risks:
liquidity, credit, counterparty and operational risks. Prudent investment policies can reduce but not eliminate
such risks. The riskiness of stablecoins will over time lead to them being traded at variable prices, making
them unsuitable as risk-free assets.
Risks could theoretically be eliminated by allowing full-reserve or narrow stablecoins to hold their
reserve assets entirely in the form of risk-free deposits at the central bank. This would avoid custody and
investment risks for stablecoins and underpin their commitment to reimburse coin holders at par value at all
But other fundamental problems would then emerge. In fact, this would be tantamount to outsourcing the provision
of central bank money. It could even threaten monetary sovereignty if a stablecoin were to largely displace
sovereign money. And narrow stablecoins could divert sizeable deposits away from banks, with potential adverse
consequences for the financing of the real economy.
Only central bank money can provide an anchor of stability. The solution is to extend todays two-tier monetary
system into the digital age. This system is built on the complementary roles of central bank money and
commercial bank money.
Central bank money is currently available for retail use in only physical form cash. But the digitalisation of
payments is eroding the role of cash and its ability to provide an effective monetary anchor. Central bank
digital currencies would instead preserve the use of public money for digital retail payments. By offering a
digital, risk-free common denominator, a central bank digital currency would facilitate convertibility among
different forms of private digital money. It would thus preserve the singleness of money and protect monetary
sovereignty. The ECB is working on a digital euro precisely for these reasons.
To preserve its crucial role, public money must also continue to be used as a settlement asset for wholesale
The Eurosystem currently provides settlement in central bank money for wholesale transactions with its TARGET
services. And we are exploring what would happen if new technologies were to be widely adopted by the financial
industry. Whether such a scenario will materialise is uncertain, but we must be ready to respond if it does. Our
response may include making central bank money available for wholesale transactions on one or more distributed
ledger technology platforms, or creating a bridge between market DLT platforms and existing central bank
By ensuring that the role of central bank money as the anchor of the payment system is preserved for both retail
and wholesale transactions, central banks will safeguard the trust on which private forms of money ultimately
Let me conclude. Born in the depths of the global financial crisis, crypto-assets were portrayed as a
generational phenomenon, promising to bring about radical change in how we pay, save and invest. Instead, they
have become the bubble of a generation. It is now obvious to everyone that the promise of easy crypto-money and
high returns was a bubble doomed to burst. It turns out that crypto-assets are not money. Many are just a new
way of gambling.
There is an urgent need globally for regulation to protect consumers from the risks of crypto-assets, define
minimum requirements for crypto firms risk management and corporate governance, and reduce the run and
contagion risks of stablecoins. We should also tax crypto-assets according to their social costs.
But regulation will not turn risky instruments into safe money. Instead, a stable digital finance ecosystem
requires well-supervised intermediaries and a risk-free and dependable digital settlement asset, which only
digital central bank money can provide.