Steven Maijoor: Public trust - the litmus test of financial innovation
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands
Bank, at the Institutional Digital Assets and Crypto Regulation Symposium, London, 17
November 2022.
* * *
Hello everyone.
It is great to be back in London - one of the great financial centres in today's globalised
world. Before I delve into the developments of the day, I'd like to draw some parallels
between crypto-asset markets and a key historic financial innovation. I'll argue that the
lessons we learned in the past remain relevant for our regulatory efforts today. I'll also
argue that successful financial innovations must be underpinned by public trust if they
are to stand the test of time.
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To illustrate, let's go back to 17 and 18 century Amsterdam, which became a staging
ground for significant financial innovation. After a long and arduous struggle, the
Netherlands was able to gain independence from the Spanish empire. This kickstarted
a period of rapid economic growth. One of the developments that proved instrumental
to the Dutch economic and financial success was the emergence of a stablecoin avant
la lettre. My colleagues from the Bank for International Settlements (BIS) and the Dutch
Central Bank (DNB) have written a very thoughtful piece on the Bank of Amsterdam
and its proto-stablecoin, the Guilder, but allow me to summarize.1
Four centuries ago, many different metal coins circulated in the Netherlands. And
exchanging one coin for the other happened in the streets. You can imagine how
cumbersome trading was.
But then, in 1609, the Bank of Amsterdam was founded. And its services were simple.
The Bank of Amsterdam allowed merchants to deposit their metal coins - any coins that
were in circulation - into a deposit account. It would then value these coins against
each other and credit merchants with Bank Guilders. And this would allow for easy
transactions between deposit accounts.
This is a great example of human innovation. Just as the entire financial system is
indeed proof of our immense human creativity.
The reason that today, after so many centuries, we still have a well-functioning financial
system - a system that, I dare say, has generally improved over the course of many
years - is because, sooner or later, the litmus test for any financial innovation is the
public's trust.
That trust is the true bedrock of our financial system. That trust allows for innovations to
be incorporated in the financial system, and to be further advanced. Or for innovations
to be found flawed and to be cast aside.
lack of trust
And it is to a that the Bank of Amsterdam ultimately fell victim.
That happened once the Bank of Amsterdam started doing more than its charter
allowed. Under political pressure, it moved away from full reserve backing to issuing
loans.
Eventually, it was the combination of flawed governance and a lack of transparency that
led to the downfall of the Bank of Amsterdam. They allowed the Bank of Amsterdam's
management to operate in violation of its founding principles. Despite this opacity, it did
not take the general public long to figure out the Bank's safes were emptying out
rapidly. A revelation that led to several severe runs on the bank. The institution never
really recovered from this break-down of public trust and was ultimately dismantled in
1820.
Since then, the public's trust in the financial system has been reinforced by rules and
regulations - and, of course, the enforcement of those rules and regulations. Whether
they deal with governance, transparency or other aspects of trustworthiness.
Flash forward to today. And today's headlines.
Crypto-assets, or to be more exact the underlying distributed ledger technologies, are
innovations with the theoretical promise of real societal benefits.
But, when there is no way to know who is to be trusted in the crypto eco-system, the
potential benefits will certainly not outweigh the risks.
2
What I often hear, is "this time is different". "This time, there is no need for rules and
regulation." "This time, there is no need for supervision."
Well, just in the past few days alone, we've been able to see that these times may not
be so different at all. And that is no surprise. Because the crypto eco-system is not
nearly as different from traditional finance as is often proclaimed.
Many activities in the crypto-ecosystem strongly resemble activities in traditional
finance. Think for instance about lending, deposit-taking, trading, or insurance, amongst
others.
And in resembling traditional finance, crypto-assets also borrow risks from traditional
finance. These include leverage, liquidity mismatches, or interconnectedness.
And going beyond theory: however attractive removing central intermediaries might
sound, in practice , distributed ledger technology will come with other costs and frictions
3
- such as significant energy consumption or a limited transaction throughput when
settling a large number of transactions.4
So, yes - the technology underlying crypto-assets is different from the technology used
in traditional finance. And yes - this technology holds the promise of potential
improvements. But, the economics underlying the crypto eco-system are actually not so
different from traditional finance. So no - "it won't be so different this time". As always,
too little supervision and regulation will attract malicious actors, purporting to offer
reliable services.
At present many crypto markets are characterised by pseudonymity and high levels of
ex ante
information asymmetry. Which means that it is often impossible to know which
actors have bad intentions. Or indeed, which platforms are at risk of the type of
overreach that the Bank of Amsterdam was tempted into. Recent crypto-market
developments have highlighted once more the age-old lesson that trust is built in drops
and lost in buckets.
As always, the financial innovation of the day will undergo the same public scrutiny as
the Bank of Amsterdam faced three centuries ago. Whether with regards to reserve
backing, governance, transparency or other issues.
And after carefully scrutinizing the current crypto eco-system, the Financial Stability
5
Board (FSB) sees legitimate reasons for concern. As one of the guardians of financial
stability, we believe the rapid growth of these markets in the presence of structural
vulnerabilities and incomplete regulation and supervision, mean crypto-asset markets
could soon reach a point where they represent a threat to the stability of the global
financial system. Especially given the large and continued institutional interest from
traditional financial parties. I think the mere fact that we - crypto-native companies,
regulators and traditional institutions - are all together here today, shows crypto cannot
simply be considered a fad.
The FSB's concerns are underscored by the fact that many crypto activities are not in
compliance with existing regulation or take place outside of the regulatory perimeter;
that existing crypto-asset regulation differs across jurisdictions; and that monitoring of
financial stability risks is challenging given limited regulatory reporting and public
disclosure.
So, enhanced regulatory action is definitely required. Let me touch upon three elements
that are important for the way forward.
First, the FSB is well-aware that the cross-border nature of crypto-assets poses an
obvious challenge for national supervisors. Inherently cross-border activities, like those
conducted in the crypto-ecosystem, require a regulatory response that is coordinated
across borders. And this is exactly what the FSB has been working on.
Regulators and supervisors will not only need to work together across borders, but also
across sectors. All kinds of activities can be found in crypto-asset markets: lending,
deposit-taking, and insurance, to name a few. At the same time, financial supervision is
often organized across different sectoral authorities with different mandates.
Meanwhile, cross-border collaboration is still too often organized along sectoral lines. In
our recommendations, we urge authorities to look beyond these sectoral boundaries. In
its own work, the FSB aims to overcome sectoral lines by coordinating its crypto policy
work with the different sectoral standard-setters, both within and outside its membership.
Second, crypto activities in many ways resemble the activities of traditional finance.
That is why we think crypto activities should be regulated on the basis of the 'same
activity, same risk' principle. This would ensure that financial activities, no matter how
they are delivered to end-users, are treated in a technology-neutral manner. To
advance this, the FSB has published two consultative reports with recommendations:
One report that reviews the FSB's high-level recommendations of October 2020
for the regulation, supervision, and oversight of "global stablecoin" arrangements,
and which has proposed revisions to strengthen the recommendations in light of
recent developments.6
And another report which has focussed on broader crypto-asset activities and
markets and proposes recommendations that seek to promote the consistency
and comprehensiveness of regulatory, supervisory and oversight approaches to
7
crypto-asset activities and markets. It also proposes strengthening international
cooperation, coordination and information-sharing.
The principles that we have proposed are high-level - which means that they can be
flexibly applied by national authorities and can be adapted as the market further evolves.
Third, while the FSB work has focused on the financial stability implications of
cryptoasset markets, there are of course also other policy goals that warrant attention from
regulators. Currently, we see wide-spread fraud and malicious behaviour in the
cryptoecosystem. So market integrity, consumer and investor protection, as well as AML/CFT,
should also be on regulators' agendas. And not only on theirs, also on the agenda of
crypto-service providers. Indeed, the industry needs an increased 'risk consciousness'
and to build up its resources to monitor and mitigate all kinds of financial risk.
The FSB's proposals, along with the work undertaken by the standard-setting bodies
(SSBs), should provide a foundation for greater consistency and cooperation among
authorities in the regulation and supervision of crypto-asset activities and markets.
Until 15 December 2022, the FSB is soliciting comments on its published
recommendations. And I encourage you to participate in this public consultation. We
want to hear from you, because we want our policy proposals to be as effective and
efficient as possible.
As you can see, it takes time to develop a regulatory and supervisory approach. But it is
not new for regulators and supervisors to have to deal with regulatory catch-up. This is
inherent to a landscape that supports financial innovation.
Nevertheless, the speed of developments in the crypto eco-system, including the recent
market turmoil, has given us all the more reason to develop an appropriate and globally
consistent regulatory framework. Catching up with the rapidly changing environment is
therefore our highest priority. A catch-up that strengthens the stability of the financial
system. A catch-up that strongly underpins the public's trust in a system that has
developed and evolved over many centuries.
The Bank of Amsterdam offers an inspiring example of how financial innovations can
advance an economy - and of how things can turn out badly. It is the FSB's goal to
learn from the past - and to stimulate innovations that improve the global financial
system, while also advancing and protecting its stability. Crucial in this regard, is
adequate regulation, and supervision, of governance, risk management, and
transparency. These are quintessential elements of a well-functioning financial system
that passes the litmus test of the public's trust.
I trust you are with me on this.
Thank you.
1
The full history of the Bank of Amsterdam, and the lessons it carries for the
governance of digital money, has been described by Jon Frost (BIS), Hyun Song Shin
(BIS) and Peter Wierts (DNB) in a BIS working paper (No. 902): An early stablecoin?
The Bank of Amsterdam and the governance of money (2020)
2
I have to credit Carmen M. Reinhart and Kenneth S. Rogoff with popularizing this
phrase.
In their seminal work - "This Time Is Different" (2009, Princeton University Press) -
they have described the 'this-time-is-different syndrome' showing how unrealistic
optimism has afflicted bankers, investors and policy makers in the periods leading up to
financial crises over the past 180 years.
3
As has been evidenced for example by DNB research titled "the carbon footprint of
bitcoin" (2021, DNB Analysis series) or the Cambridge Bitcoin Electricity Consumption
Index .
4
See for example the BIS Annual Economic report (2022), Chapter III .
5
For a full overview of the vulnerabilities that have been identified in relation to
cryptoassets, please refer to the FSB report "Assessment of Risks to Financial Stability from
Crypto-assets " published in February 2022.
6
Full report can be found here .
7
Full report can be found here.