Rapid Growth and Concentration Found in Digital Asset Market, OFR Data Analysis Reveals

A recently published analysis conducted by Francisco E. Ilabaca and Vy Nguyen highlights the significant growth and concentration observed in the digital asset market. The study, utilizing data curated by the Office of Financial Research (OFR), sheds light on the trends shaping this burgeoning industry.

According to the findings, the total value of the crypto market, known as crypto market capitalization, skyrocketed from $100 billion to approximately $2 trillion in 2021. This staggering increase occurred within a span of just three years, as reported by CoinMarketCap. Furthermore, the study indicates a parallel growth in the number of companies operating in this sector.

The authors of the analysis employed a dataset provided by the OFR, revealing that approximately 80 U.S.-based intermediaries in the crypto industry contribute between 5% and 10% of the global crypto trading volumes. Notably, the top quartile of these firms is responsible for a staggering 90% of transaction volumes and holds the largest amount of customers' digital assets. This concentration of power within a select group of companies raises concerns about potential risks to financial stability.

The report marks the first comprehensive analysis conducted by the OFR on the key features of the digital assets market, using data reported by crypto intermediaries. All intermediaries offering trading platforms for convertible virtual currencies are required to register as money services businesses (MSBs) with the U.S. Department of the Treasury's Financial Crimes Enforcement Network. These MSBs are then obligated to report data to state regulators, with many states utilizing the MSB Call Report for this purpose. The authors utilized the data reported by these crypto intermediaries to construct a dataset representing approximately 5% to 10% of the digital assets market at any given time.

The analysis further reveals the rapid growth experienced by digital assets in recent years. In 2021, companies reported conducting over 2 billion transactions amounting to $1.4 trillion in virtual currency activities. Comparatively, in 2020, 586 million transactions worth $193 billion were conducted. The final quarter of 2021 alone saw virtual currency transactions totaling $367 billion, with an average company reporting $4.7 billion in transactions. The amount of virtual currency held on behalf of customers also surged, reaching $240 billion by the end of 2021, compared to $60 billion the previous year.

The study emphasizes the high concentration of digital asset trading among top intermediaries. At the end of 2021, the top quartile of firms accounted for more than 96% of all activities, representing $356 billion out of the $367 billion in transactions. These firms also held the majority of digital assets, with over $11 billion reported in Q4 2021, constituting roughly 65% of the total digital assets across all companies in the sample. Out of the $240 billion in virtual currency held on behalf of customers, the 5 largest firms held $204 billion, illustrating the significant degree of concentration in the industry.

The analysis indicates that digital asset transactions primarily revolve around trading between digital assets themselves. On average, virtual currency to virtual currency transactions accounted for approximately 48% of all transactions, followed by U.S. dollar to virtual currency transactions at 32%, with the remaining portion comprising virtual currency to U.S. dollar transactions.

Digital asset platforms and other intermediaries play a crucial role in providing investors access to virtual currencies. The study highlights the striking resemblance between these intermediaries and traditional financial institutions, such as broker-dealers, exchanges, custodians, and deposit-taking institutions. Despite being primarily regulated as MSBs, their activities raise questions about the adequacy of risk management and whether their operations are appropriately ring-fenced. While the MSB Call Report provides valuable insights into the activities of intermediaries in the digital asset markets, it captures only a fraction of the global crypto trading activities. The authors emphasize the need for more detailed and frequent data on the various types of crypto assets traded and held to enable regulators to effectively assess potential financial stability risks arising from these activities.

The analysis aligns with recent recommendations made by the Financial Stability Oversight Council, which identified gaps in data within the crypto-asset ecosystem. The Council called upon its members to consider collecting data that would facilitate assessments of financial risks associated with crypto assets.

Source: Office of Financial Research, MSB Call Report, S&P Cryptocurrency Index Series (https://www.financialresearch.gov/the-ofr-blog/2023/05/30/data-analysis-shows-high-growth-high-concentration-in-digital-asset-market/)