The European Securities and Markets Authority (ESMA) has asserted that Decentralized Finance (DeFi), while not yet a significant threat to overall financial stability, warrants continuous scrutiny, as per a report unveiled on October 11. Titled “Decentralized Finance in the EU: Developments and Risks,” the document explores the budding ecosystem’s pros and cons, ultimately determining that its potential threat to financial stability is presently minimal. With the entire cryptocurrency market valued slightly over $1 trillion and DeFi’s total value locked (TVL) merely at $40 billion, in contrast to the EU financial institutions’ $90 trillion assets in 2021, the crypto market equates to the size of the EU’s 12th largest bank or 3.2% of all assets of EU banks.
Despite investigating several cryptocurrency upheavals in 2022, including the Terra ecosystem and FTX collapse, the ESMA acknowledged that such a crypto “Lehman moment” did not significantly affect traditional markets. However, it did spotlight that DeFi exhibits characteristics and susceptibilities akin to conventional finance, encompassing liquidity and maturity disparities, leverage, and interconnectedness.
While investment in DeFi is comparatively small, the regulator underscored severe risks to investor protection, attributing them to the highly speculative nature of numerous DeFi setups, vital operational and security weak points, and the absence of a distinctly accountable entity. This, it warned, could metamorphose into systemic risks if DeFi gains substantial momentum or forms notable links with conventional financial markets.
Furthermore, the ESMA noted a “concentration risk” related to DeFi activities, with activities centralized in a few protocols, the three largest of which constitute 30% of the TVL. It expressed concerns that the breakdown of any of these dominant protocols or blockchains could send shockwaves throughout the entire system. Post-publication of its second consultative paper on the Markets in Crypto-Assets (MiCA) regulations earlier this month, the regulator is intensifying its focus on DeFi and cryptocurrency markets.
Get $200 Free Bitcoins every hour! No Deposit No Credit Card required. Sign Up