The European Systematic Risk Board (ESRB), an EU financial watchdog, is advising restrictions on cryptocurrency leverage to preserve the financial stability of the overall market. Historical precedent suggests that firms often collapse under high-leveraged bets, leading to broader market cash shortages and potential recessions.
The ESRB’s suggestion, as reported by Reuters, primarily targets investment funds, exchanges, and similar entities involved in cryptocurrency trading. High-leveraged trades, even for retail investors, can result in a total loss of initial capital—a phenomenon known as liquidation. Given the high volatility of cryptocurrencies, traders frequently face significant liquidation losses, with a recent 24-hour period seeing over $82 million lost.
“Systemic risks could arise quickly and suddenly,” warned the ESRB. “If the rapid growth trends observed in recent years were to continue, crypto-assets could pose risks to financial stability.” The board’s concerns are not unique; Japan’s Financial Service Agency has already enforced similar limitations, restricting investors from borrowing more than twice their investment amount for leverage trades. This conservative approach may have contributed to FTX’s Japanese entity enabling withdrawals earlier this year.
While the ESRB oversees the broader market and works to mitigate systemic risks, it lacks the direct authority to enforce crypto leverage limitations. Instead, its role is to propose these recommendations for inclusion in future versions of the EU’s Market in Crypto-Assets (MiCA) legislation.
Last week, all 27 EU member states unanimously approved the MiCA rules, slated to take effect from July 2024. With the ESRB’s recommendations, the European Union may see more comprehensive crypto regulations in the near future.
