The Financial Stability Board (FSB) is intensifying its examination of the complex realm of decentralized finance (DeFi), driven by concerns over potential spillover risks to traditional financial systems.
DeFi refers to services in crypto-asset markets that aim to replicate certain functions of the traditional financial system while eliminating the need for intermediaries. In a report presented to the G20, the FSB observed that, despite the innovative nature of many DeFi processes, they do not significantly diverge from traditional finance in terms of their functions or the vulnerabilities they face.
However, the FSB points out that the lack of inherent value in many crypto-assets associated with DeFi, combined with their extreme volatility, amplifies the consequences of these vulnerabilities when they arise, a sentiment underscored by the recent turmoil in crypto markets.
According to the FSB, “The extent to which these vulnerabilities can lead to financial stability concerns largely depends on the interlinkages and transmission channels between DeFi, traditional finance, and the real economy.” Currently, these interlinkages are limited; however, a significant expansion of the DeFi ecosystem could increase the potential for spillovers to traditional finance.
The FSB plans to conduct further analysis on the growth and ramifications of asset tokenization, as this could enhance connections between crypto-asset markets, DeFi, traditional finance, and the real economy. Additionally, the Board aims to investigate ways to address data gaps for measuring and monitoring the interconnectedness of DeFi in cooperation with regulatory authorities.
The FSB’s upcoming policy recommendations for international regulation of crypto-asset activities may require adjustments to adequately reflect DeFi-specific risks and improve the application and enforcement of existing rules. The FSB is expected to release its final regulatory framework for crypto-assets in July 2023.