The challenges and responses of Crypto Assets to global financial governance (Part 1)

Author of this article:

■ Zhang Ming Deputy Director of the National Financial and Development Laboratory, Deputy Director of the Institute of World Economy and Politics, Chinese Academy of Social Sciences

■****Bao Hong Institute of International Affairs, The Chinese University of Hong Kong, Shenzhen

■ Wang Yao Researcher at the National Finance and Development Laboratory

Using a combination of literature analysis and case studies, this paper delves into the challenges of cryptocurrencies to global financial governance. The study finds that the challenges posed by cryptocurrencies are mainly reflected in three aspects: first, it increases the vulnerability of the global financial system; Second, the relevant abuses have amplified the loopholes in international financial regulation; Third, developing countries are exposed to a higher risk of currency substitution. In view of the above problems, this paper puts forward policy suggestions from the aspects of exploring the construction of a new financial governance institution or framework, promoting the establishment of a global stablecoin regulatory mechanism, promoting the intelligence and precision of cryptocurrency supervision, and accelerating the research and development and cooperation of central bank digital currency (CBDC). The innovation of this paper is that, on the one hand, combined with the latest cases and data, it systematically extracts the three core challenges of cryptocurrencies to global financial governance; On the other hand, incorporating the characteristics of cryptocurrencies into the analytical framework of financial vulnerability theory not only reveals its amplification channel for the vulnerability of the financial system, but also expands the application scope of the theory in the context of digital finance.

The original text was published in the 3rd issue of “Financial Regulatory Research” in 2025. For ease of reading, it is published in two parts, this being the first part.

Introduction

Cryptocurrency, represented by Bitcoin, is an emerging thing that came into being and developed rapidly in the 2008 international financial crisis. From the perspective of development motivation, cryptocurrencies are based on advanced cryptography and distributed ledger technology (especially blockchain technology), aiming to build a decentralized global digital payment and value transfer system that transcends traditional national regulatory frameworks (Nakamoto, 2008). Cryptocurrencies are commonly used in payment and settlement, financial investment, and many illegal financial activities, and have attracted extensive attention from global financial governance institutions and academia since their inception (Li Jianjun and Zhu Yechen, 2017, Song Shuang and Xiong Aizong, 2022). With the rapid development and wide application of cryptocurrency, its impact on global financial governance has become increasingly prominent, especially in the following three aspects: First, the popularity of cryptocurrency has had a profound impact on cross-border capital flows, financial market stability and consumer rights protection, making it the focus of current mainstream financial governance institutions and major countries. Among them, the Financial Stability Board (FSB) has been tracking the market risks of cryptocurrencies since 2018, regularly sorting out and updating the potential threats they pose to global financial stability. In 2022, the FSB also issued a principle document for global stablecoin regulation for the first time. Second, the anonymity and cross-border nature of cryptocurrencies increase the risk of illegal financial activities such as money laundering and terrorist financing, and put forward higher requirements for financial regulators. In fact, the increasing sophistication of cryptocurrency-based money laundering techniques, coupled with the lack of effective coordination between jurisdictions, has led to significant difficulties in regulating and combating related criminal activities. Third, in view of the fact that the issuance and circulation of cryptocurrencies are not controlled by the central bank, its price fluctuations and changes in trading volume are considered to have a significant impact on the formulation and implementation of monetary policy. In particular, after Facebook proposed the Libra plan, the challenge of stablecoins to macro policy has received special attention from institutions such as the Group of Seven (G7), the International Monetary Fund (IMF) and the Bank for International Settlements (BIS), which have intensified their research.

In response to the above challenges, in recent years, the G20 as the core platform and the FSB, IMF, BIS, International Organization of Securities Commissions (IOSCO), Financial Action Task Force on Money Laundering (FATF) and other pillar institutions have formed a global governance structure (Song Shuang and Xiong Aizong, 2022), which has continued to strengthen the supervision of cryptocurrencies through in-depth and close follow-up research, the issuance of regulatory guidelines, and the deepening of international cooperation. For example, the FATF, FSB and IMF publish relevant research and guidance recommendations almost every year, and IOSCO also publishes regulatory guidance for private currency exchanges. As the country with the strictest supervision of cryptocurrencies in the world, China clearly pointed out as early as 2013 that cryptocurrencies are a virtual commodity with high risks, and required relevant domestic companies to do a good job in risk control. Subsequently, from 2017 to 2021, China successively adopted a variety of measures to further strengthen the supervision of cryptocurrencies and the prevention of new financial risks, including the closure of domestic cryptocurrency exchanges, and a complete ban on the use of cryptocurrencies for financing, speculation and “mining” activities. In addition, in May 2023, the European Union introduced the world’s first comprehensive cryptocurrency regulation, The Markets in Crypto Assets regulation bill (MiCA), to regulate crypto market operations, improve regulatory transparency, and curb illegal financial activities. However, due to the continuous innovation in the cryptocurrency field, coupled with the combined effect of political factors (increased lobbying efforts by industry institutions) and economic factors (the Federal Reserve’s extreme monetary policy in recent years), the application scope of cryptocurrencies has further expanded, and the popularity has further increased, and the challenges to global financial governance have not eased, but have become more severe. In particular, after Trump was re-elected as president of the United States, his strong “de-regulation” policy has further exacerbated the impact of cryptocurrencies on the global financial governance system, making the problem more complex and urgent to solve.

In this context, this paper discusses the core challenges posed by cryptocurrencies to global financial governance and their specific manifestations and impacts, in order to provide reference for the adjustment of the global financial governance system and subsequent research. Based on the analysis and collation of existing research results and the latest factual evidence, this paper summarizes the core challenges of cryptocurrencies to global financial governance into the following three aspects: First, cryptocurrencies have formed a large-scale global investment market, which has the characteristics of high volatility, contagion and difficulty in being fully regulated, resulting in it becoming an important destabilizing factor in the current international financial system. Second, in recent years, the use of cryptocurrencies to evade regulation has become more and more rampant, especially the entry of terrorist organizations and some state actors, which will significantly amplify the loopholes in the global financial governance system. Third, in the current round of US dollar interest rate hike cycle, the adoption rate of cryptocurrencies has increased rapidly, which has exposed more and more developing countries to the risk of currency substitution, and has also posed a continuous and far-reaching challenge to their financial governance capabilities. In view of the triple challenges and the reasons behind them, this paper puts forward the following policy recommendations: explore the construction of a new financial governance institution or framework, promote the establishment of a global stablecoin regulatory mechanism, promote the intelligence and precision of cryptocurrency supervision, and accelerate the research and development and cooperation of central bank digital currency (CBDC).

Compared with the existing research and practice, the marginal contribution of this paper is mainly reflected in the following two aspects: on the one hand, this paper starts from the three main motives of the use of cryptocurrencies for investment transactions, evasion of regulation, and alternative options for sovereign currencies, combined with the latest cases and data, and systematically refines the three core challenges of cryptocurrencies to global financial governance. This not only provides a clear research framework for follow-up research and policy formulation, but also further enriches the research system in the field of cryptocurrency and global financial governance. On the other hand, the traditional financial vulnerability theory mainly focuses on issues such as bank runs, asset price bubbles, and credit market failures, and does not fully take into account the increasingly close connection between cryptocurrencies and the traditional financial system. This paper integrates the characteristics of cryptocurrency, such as high volatility, difficult regulation and cross-border circulation, into the theoretical framework of financial vulnerability, which not only reveals its amplification channel for emerging things to the vulnerability of the financial system, but also expands the application scope of the theory in the context of digital finance.

The cryptocurrency market has increased the vulnerability of the global financial system

After Bitcoin was launched to the public in early 2009, its global attention and popularity have skyrocketed, and its price has exploded, rising from near zero to a “sky-high” price of about $109356 per coin at its peak (January 19, 2025) in just 15 years. At the same time, the Bitcoin market has also developed into the world’s largest cryptocurrency market by market capitalization, with a daily trading volume of tens of billions of dollars, making it one of the most active financial markets in the world. As of the end of February 2025, there are more than 10,000 types of cryptocurrencies in the world, with a total market capitalization of about $2.8 trillion. The sheer size of the market and trading activity have made cryptocurrencies an existence that cannot be ignored on the global financial governance agenda. Many studies have also confirmed that the cryptocurrency market is an important factor affecting the stability of the global financial system, especially increasing the vulnerability of the global financial system (Yue et al., 2021, Iyer, 2022).

(1) Key Factors of Cryptocurrency Market Affecting the Global Financial System

From a theoretical perspective, the “interconnectivity” of the modern financial system significantly increases the complexity and vulnerability of financial networks. In this context, abnormal fluctuations in a single market can produce a “domino effect,” affecting financial markets in other regions and types around the world, and creating systemic financial risk through the web-like structure of the transmission chain of the financial system (Yang Zihui and Zhou Yinggang, 2018). In recent years, the severe volatility of the **** cryptocurrency market has increasingly impacted the global financial system, mainly due to three key factors: first, the high volatility of the **** cryptocurrency market can easily trigger panic among investors and quickly transmit to other markets. Second, the difficulty in regulating **** cryptocurrencies exacerbates the formation and spread of risks. Third, the connection between **** cryptocurrencies and traditional financial markets is becoming increasingly tight, expanding the channels of contagion through financial products (such as Bitcoin futures and crypto asset funds).

1. The high volatility and contagion of the cryptocurrency market

The Bitcoin market gradually satisfies the weakly efficient market hypothesis over time, and its price reacts immediately to public market information, so the price fluctuations are not only very drastic, but also have significant volatility aggregation characteristics (Urquhart, 2018). Compared with Bitcoin, there are relatively few studies on the volatility of other cryptocurrencies, and there may be differences due to market size, liquidity and other factors, but on the whole, other cryptocurrencies also show similar volatility characteristics, reflecting higher market risk and uncertainty. This article selects four cryptocurrencies that were launched earlier and have high visibility and market liquidity, and briefly compares them with the volatility of the US stock market (NASDAQ). Looking at Table 1, the standard deviation of the returns of Bitcoin, Ethereum, Litecoin, and Dogecoin is much larger than that of the Nasdaq, meaning that the former has higher volatility. The maximum yield of Dogecoin is as high as 1.516, which means that buying Dogecoin can theoretically achieve a maximum of 150%/day.

Due to its high liquidity and market share, Bitcoin plays a central role in the volatility contagion phenomenon of the overall cryptocurrency market. On the one hand, as a major contributor to the volatility spillover of the cryptocurrency market, Bitcoin’s sensitivity and quick response to news events tend to drive price volatility in other small cryptocurrencies (Koutmos, 2018, Moratis, 2021); On the other hand, there is a significant co-jump in returns within the crypto market, indicating that the diversification of cryptocurrencies has not effectively reduced the risk of volatility (Yue et al., 2021). More critically, the long-term high level of synchronized volatility between Bitcoin and major cryptocurrencies such as Ether and Dogecoin further amplify the systemic risk in the market (see Figure 1). In addition, looking at the volatility contagion trend between Bitcoin and the US NASDAQ index, we can see that the volatility correlation between the two has increased significantly after the introduction of large stimulus measures in the United States at the end of 2020, indicating that cryptocurrencies have put additional pressure on the stability of financial markets.

2. The cryptocurrency market is difficult to effectively regulate

One important reason is the technological characteristics of cryptocurrencies. Taking Bitcoin as an example, it not only conducts transactions based on anonymous digital addresses (theoretically, one person can have thousands or even more accounts), but it can also operate 24/7 via the internet, allowing it to easily cross borders and break geographical and temporal limitations. Although government regulations can prevent people from using cryptocurrency exchanges, these measures cannot effectively prohibit individuals from using Bitcoin. The latter can be exchanged with local currencies through peer-to-peer transactions, thus circumventing currency controls.

Another key reason is the speed at which cryptocurrencies are being innovated and adopted. Not only has this led to a relative lag in research and regulation, but most economies have a friendly regulatory attitude towards it. In recent years, new directions such as “cryptocurrency initial public offerings (ICOs)”, “non-fungible tokens (NFTs)”, “decentralized finance (DeFi)”, “the third generation of the Internet (Web 3.0)” and the rise of new forms of digital economy have been regarded as new economic growth directions by many economies. At the same time, most of the world’s countries currently allow cryptocurrencies to be traded freely (Borri and Shakhnov, 2020). According to the international statistical agency Triple-A, as of 2023, there are more than 400 million cryptocurrency users worldwide, with an ownership rate of more than 4.2%. The polarization of major countries in the global governance of cryptocurrencies also makes it difficult to implement regulation and governance (Song Shuang and Xiong Aizong, 2022).

3. The cryptocurrency market is accelerating its integration into the existing financial system

The emergence and growth of cryptocurrency exchanges has greatly facilitated the trading between cryptocurrencies and fiat currencies and further strengthened the connection between markets. As of April 2024, there are 765 exchanges around the world, and most individual and institutional investors can buy cryptocurrencies online through major exchanges, and the payment method can be credit or debit card, wire transfer, or cash (via Bitcoin ATMs), according to cryptocurrency data service Coinmarketcap. At the same time, institutional investors and financial regulators in major countries are also promoting the integration of cryptocurrencies into the traditional financial system. As early as 2017 and 2020, relevant U.S. exchanges launched Bitcoin futures contracts and corresponding option products respectively, and built an investment product system including funds, trusts, insurance, derivatives, etc., greatly simplifying the channels for institutional investors to enter the cryptocurrency market. Morgan Stanley’s research shows that among Coinbase, the world’s second-largest cryptocurrency exchange, the share of retail investors’ trading volume has rapidly declined from 80% in the first quarter of 2018 to 32% in the fourth quarter of 2021, with crypto funds, custodians, etc. becoming the dominant force in the market and contributing most of the trading volume. In early 2024, the U.S. Securities and Exchange Commission approved 11 Bitcoin ETF listing applications for the first time, and in July of the same year, it approved the first batch of Ethereum spot ETFs to list in the United States, further increasing institutional investors’ exposure to the cryptocurrency market. According to the data, as of December 2024, the total AUM of the 12 bitcoin spot ETFs has exceeded $100 billion, and they jointly hold more than 1.1 million bitcoins (about 5% of the total supply), surpassing Bitcoin founder Satoshi Nakamoto to become the largest bitcoin holder. During the same period, the market size of Ethereum ETFs was about $10.43 billion. As the new Trump administration’s expectations for crypto policy become more friendly, it will continue to increase the exposure of various types of investors in the future, potentially triggering challenges of greater regulation and scale.

(2) Channels through which the cryptocurrency market increases the vulnerability of the global financial system

Contagion (or volatility spillover) between financial markets is an important risk and uncertainty facing the global financial system today, and it is also the main way in which the cryptocurrency market affects the vulnerability of the global financial system. From a theoretical point of view, the contagion mechanism of financial markets around the world can be roughly divided into two categories: fundamental factors and non-fundamental factors. Among them, the fundamental factors, also known as the economic basis hypothesis, are based on the traditional financial theory that investors are completely rational, and believe that changes in the basic variables that affect the economy together between countries will lead to synchronous fluctuations in the financial market. However, since the cryptocurrency market does not have an economic base and is riddled with irrational investors who are mainly speculative (Cheah et al., 2015, Griffin and Shams, 2020), its volatility spillover to financial markets may be mainly through non-fundamental channels. Based on a series of FSB studies and related theoretical and empirical analysis, this paper sorts out three types of influence channels with general consensus, namely the confidence effect, the risk exposure of financial institutions, and the wealth effect.

1. Based on the confidence effect

Existing research confirms that micro-participants in the cryptocurrency market are more powerful in terms of information generation and transmission, react more quickly to external shocks, and lead investor sentiment in global financial markets because they do not require the support of the real economy and can trade 24 hours a day. When the price of a cryptocurrency changes significantly, the information shock will be quickly transmitted to other financial markets, such as stocks, and create a herd effect of buying or selling stocks in response to the fluctuations of the cryptocurrency market. In short, the cryptocurrency market, with its round-the-clock trading and quick reaction characteristics, has become an important “bellwether” for global financial markets, especially for high-risk markets. When the cryptocurrency market shows consecutive positive returns, investor confidence will further spread to other high-risk markets such as the bond market (Umar et al., 2021).

2. Risk Exposure Based on Financial Institutions

At present, Bitcoin is being included more as a risk asset (speculative instrument) in the allocation portfolios of institutional investors, which may lead to the adjustment of cryptocurrency positions leading to the convergence of other risk assets such as stocks (Iyer, 2022, Wang et al., 2022). If cryptocurrencies are seen as a hedge against stocks, there will be negative volatility spillovers when the portfolio is balanced. For example, when cryptocurrency investors suffer large losses, they may be forced to sell traditional financial assets to manage their liquidity positions. As institutional investors overtake individual investors to become the dominant investors in the cryptocurrency market, the effects of these channels continue to expand. The March 2023 U.S. banking crash provides strong evidence that cryptocurrencies are undermining financial stability through the risk exposure of financial institutions. In the case, SilverGate Capital and Signature Bank both went bankrupt due to a run on crypto deposit customers, sparked by the panic caused by the collapse of crypto exchange FTX in November 2022. Specifically, since 90% of all deposits of Silvergate Capital come from deposits of cryptocurrency-related customers (about $12 billion), Silvergate Capital was run on $8.1 billion after the FTX incident, and it had to apply to the SEC for a delay in filing its 2022 annual report, and declared bankruptcy on March 8, 2023. In contrast, despite the fact that Signature Bank is larger ($110.4 billion in total assets at the end of 2022) and accounts for about one-fifth of deposits from cryptocurrency-related customers, which is much lower than the level of Silvergate Capital, it still cannot avoid a run and bankruptcy.

3. Based on the Wealth Effect

From the available evidence, investors in cryptocurrencies are often also active equity investors who use cryptocurrencies as part of their overall wealth portfolios (Aiello et al., 2023a). As a result, some households will increase their deposits on crypto exchanges (reinvestment of the proceeds) after reaping positive crypto returns, while others will rebalance some of their crypto gains into traditional asset investments (e.g., stocks). This suggests that the cryptocurrency market has a wealth effect over other markets (Aiello et al., 2023b). In addition, cryptocurrency investments not only have significant spillover effects on other financial assets, but are also passed on to the real economy through consumption. For example, in the United States, counties with a higher percentage of crypto holdings experience higher increases in home prices after receiving high returns on cryptocurrencies (Aiello et al., 2023a; 2023b）； Conversely, if cryptocurrencies experience consecutive negative returns, it can also significantly impact investments in other assets.

(3) Characteristics of the Impact of the Cryptocurrency Market on the Global Financial System

As the Bitcoin market matures gradually, “the relationship between cryptocurrencies and financial markets” has become an important research direction in the field of economics. Particularly around 2016, the academic interest in the cryptocurrency market significantly increased (Yue et al., 2021). Based on the existing literature, it can be observed that the impact of the cryptocurrency market on the global financial system mainly presents the following three characteristics:

First, the cryptocurrency market has a wide range of volatility spillover effects on traditional financial markets. Due to the lack of economic fundamental support, the impact of breaking information and extreme events on cryptocurrencies is stronger than that of traditional financial markets, as evidenced by the fact that the price volatility of cryptocurrency markets to external shocks is usually ahead of traditional financial markets and reacts more violently (Wang et al., 2022). Against this backdrop, cryptocurrency volatility has been shown to spill over into multiple financial markets such as equities, commodities, and forex (Yue et al., 2021, Cao and Xie, 2022).

Second, this fluctuation spillover effect has significant asymmetry. Asymmetry is reflected in the direction of volatility spillovers, such as Bitcoin was found to have one-way volatility spillovers to gold, stocks, bonds, fear index (VIX), and crude oil (Elsayed et al., 2022); It is also reflected in the regional heterogeneity of the volatility spillover effect on the same market, that is, the cryptocurrency market has a significant volatility spillover effect on the stock market of some countries, but not for others (Urom et al., 2020, Cao and Xie, 2022).

Thirdly, after the COVID-19 pandemic, the cryptocurrency market has a stronger spillover effect on the stock market. In horizontal comparison, under the extremely loose financial environment during the pandemic, the spillover effect of cryptocurrencies (including Bitcoin and stablecoins) on the stock market has significantly increased compared to key asset classes such as the 10-year U.S. Treasury bonds, gold, and specific currencies (USD, EUR, CNY); in vertical comparison, compared to the sample from 2017 to 2019, the spillover of Bitcoin to the S&P 500 index increased by about 16 percentage points, while the spillover to the MSCI Emerging Markets Index increased by 12 percentage points (Iyer, 2022).

(This article is sourced from the Journal of Financial Regulation, Issue 3, 2025)