ECB on the Risks of Stablecoins and Decentralized Finance (DeFi)
In a July 11 bulletin, the European Central Bank (ECB) examined the financial risks in the cryptocurrency ecosystem.
Authors Alexandra Born and Josep Vendrell Simon take a look at sectors of the industry that have proven particularly volatile recently, including decentralized finance (DeFi) and stablecoins in particular.
A risk to the traditional financial system?
The authors of the bulletin note that the ecosystem has become significantly more complex with the addition of numerous new projects and features, which, along with growing institutional interest, has led to entanglements with the traditional financial system. It is also mentioned that a collapse of one of the largest stablecoins could transfer risk to the financial system if the crypto market becomes large enough.
Stablecoins are also “unsuitable as a practical means of payment”, the report says, and the authors fault the speed and cost of transactions. The report notes that stablecoin penetration in the region is limited, as European payment service providers have not been very active in stablecoin markets.
While the ECB called for urgent regulation and oversight, it also noted that the ecosystem does not currently pose a risk to euro area financial stability. MiCA is cited as a step in the right direction.
The authors also commented on DeFi, pointing out that it suffers from many of the problems of the traditional financial industry, but that what distinguishes it is that it acts as a catalyst for those problems.
“… certain characteristics, such as how assets are held, how the system is managed, distinguish it from traditional finance. DeFi is subject to many of the same vulnerabilities as traditional finance, including those caused by excessive leverage and risk-taking, liquidity mismatches, and interconnectedness. However, new technology and the way services are delivered can exacerbate certain vulnerabilities and lead to additional specific risks.”
Although the bulletin addresses issues that have been repeatedly discussed by regulators, the report manages to address the issues raised in an objective and nuanced manner, which is a promising sign for the future of regulation in Europe.