(Editor's Note: In this series of articles, we answer the pressing Questions That Matter on the uncertainties that will shape 2024--collected through our interactions with investors and other market participants. The series is aligned with the key themes we're watching in the coming year and is part of our Global Credit Outlook 2024.)
Institutional interest in and adoption of digital assets and blockchain technology will continue to grow in 2024, supported by technological advances. We expect regulators to firm up their stances in key jurisdictions before activity volumes and related risks represent a key risk for traditional finance.
How this will shape 2024
Consolidation of technological developments will set the scene. Although crypto markets have endured a rough 18 months, technological progress has continued at a steady pace to address key inhibitors to institutional adoption of blockchains in financial markets. In 2023, innovations in interoperability solutions have supported increasingly elaborate institutional test cases across different private and public blockchains. The growth of layer 2 roll-ups (a blockchain network built on top of a layer 1 blockchain that aims to add functionality and speed) within the Ethereum ecosystem, and in particular roll-up chains using zero knowledge proofs--a cryptographic technique that verifies a statement is true without revealing the statement's contents--shows some promise in addressing scalability and privacy limitations that have inhibited adoption thus far, and may begin to be tested in institutional use cases.
Regulatory progress will be uneven despite coordination efforts. In July, the Financial Stability Board published its global regulatory framework for crypto-asset activities. The recommendations are high-level, and we think policy choices and their timing may vary considerably across jurisdictions. In the U.S., we expect progress will still be partly hampered by the fragmented regulatory framework and increasingly partisan political divide. In contrast, regulatory frameworks in other jurisdictions are progressing, often starting with stablecoin regulation. In the EU, the provisions for stablecoin regulation in the Markets in Crypto-Assets (MiCA) are set to apply from July 2024, while rules for other service providers will apply in January 2025. Meanwhile, in Asia, the Monetary Authority Of Singapore finalized a comparable regulation on stablecoins in August 2023.
Institutional testing of new use cases will accelerate. We think incumbent financial institutions will continue adopting blockchain technology to optimize or automate processes or create new tools for institutional users, partly supported by regulatory "sandbox" schemes in key jurisdictions. We see examples of this in the trial launch by a number of banks across regions of stablecoins or tokenized deposits. Other examples of institutional use cases include collateral mobility, foreign exchange, and cross-border payments. That said, we expect commercialization to retail clients of crypto assets will continue to progress more slowly until regulatory frameworks have greater clarity. A spot bitcoin exchange-traded fund (ETF) received regulatory approval in the EU in 2023, while several spot bitcoin and ether ETFs are currently under review in the U.S.
What we think and why
The evolution and growth of digital bond issuance is credit neutral. Digital bonds aim to automate segments of fixed-income markets leveraging blockchain technology. We expect that a small but growing universe of rated issuers will experiment further with digital bonds. But progress on widely accepted digital currencies and know-your-customer solutions is required for bonds to become fully digital and exchangeable on the blockchain. Experimentation with fully digital bonds will remain contained within regulatory pilot schemes, limiting issuers' exposure to new operational and technological risks. For example, the Swiss National Bank has announced that a pilot for fully digital bond issuances using a wholesale central bank digital currency (CBDC) will take place in the first half of 2024 (see "Canton of Basel-City's First Digital Bond Rated 'AAA'; Paves The Way For Other Issuers," published Nov. 27, 2023).
Regulated stablecoins will further some rated issuers' experimentation with applications financing the real economy. CBDCs remain a long-term prospect in the EU and U.K., and a remote one in the U.S. Their absence has thus far inhibited the issuance of fully digital bonds and on-chain financing of fiat-denominated real-world assets. As regulatory frameworks for stablecoins come into play in 2024, the emergence of regulated stablecoins could address this issue. We expect that real use cases at scale remain some years away, and therefore that ratings will not be affected by shifts in the competitive landscape for now. In 2024, we may see test cases emerge from those financial institutions leading research and development in this area.
The boundaries between centralized and decentralized finance (DeFi) will become increasingly blurred. As use cases emerge that aim to provide financing to the real economy through decentralized protocols, the centralization of some functions (for example, credit underwriting) will be necessary because of regulatory hurdles and a need for accountability when offering financial products. Regulators have thus far focused on addressing centralized crypto finance entities, but in some jurisdictions are turning their attention to DeFi. They will need to strike a balance between achieving the same levels of investor protection as in traditional finance and recognizing the unique features of DeFi. The development of regulatory frameworks should eventually create opportunities for incumbent financial institutions to participate and take on new roles in innovative projects with decentralized elements. Meanwhile, centralized crypto businesses that aim to operate globally will need to comply with emerging regulatory frameworks in key jurisdictions. That said, we do not expect that shifts in competitive dynamics will meaningfully affect credit risk in 2024.
What could go wrong
The sparse landscape of banking partners could cause issues for U.S. crypto businesses and stablecoins. In March 2023, regulators closed two of the crypto industry's main banking partners, Signature Bank and Silvergate, and major U.S. banks appear to have no appetite to pick up that mantle due to regulatory uncertainty. Crypto businesses such as exchanges or stablecoin issuers need banks to support on- and off-ramps between the fiat and crypto economies. The closure of Signature Bank and Silvergate was a meaningful factor in the March 2023 depegging of the USDC stablecoin, and limited banking rails could lead to issues with other stablecoins.
Market conditions heighten any contagion risk between crypto players. Monetary policy tightening raises the risk of accidents and an abrupt reversal in market sentiment, also compounded by prevailing geopolitical risks. In this environment, regulatory changes--or rumors thereof--can also have material effects on crypto asset pricing, as illustrated by the recent Bitcoin price volatility on rumors of the regulatory approval of a spot Bitcoin ETF established by institutional players. However, crypto asset price volatility is likely to present a credit risk only for specialized crypto businesses rather than financial institutions, whose exposure will remain minimal: adopting blockchain technology for traditional financial market use cases does not in itself create exposure to crypto asset prices.
Fragmented regulations can trip large players. Within the U.S., different policy stances between states, and between regulatory bodies, can lead to the risk of belated litigations or fines when financial institutions engage in activities with unclear regulations. For global firms, the cross-border nature of crypto activities also raises the risk of litigations in specific jurisdictions in the event of hasty forays in certain activities, especially if marketed to retail customers.
Chart 1
Charts 2 and 3
Related Research
- Utility At A Cost: Assessing The Risks Of Blockchain Oracles, Nov. 17, 2023
- What Can You Trust In A Trustless System: Public Blockchains For Financial Operations, Oct. 11, 2023
- Crypto CeFi And DeFi Must Strike A Balance To Thrive, June 22, 2023
This report does not constitute a rating action.
| Primary Credit Analyst: | Andrew O'Neill, CFA, London + 44 20 7176 3578; andrew.oneill@spglobal.com |
| Secondary Contact: | Alexandre Birry, Paris + 44 20 7176 7108; alexandre.birry@spglobal.com |
No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.