DeFi and crypto: limited systemic risks for ESRB to monitor

Christine Lagarde

Christine Lagarde – Credit: Shutterstock

L’European Systemic Risk Board chaired by Christine Lagarde believes that crypto turbulence from 2022 had a limited impact on the financial system. Exponential growth and high volatility however, justify a close monitoring.

After the Banque de France, it’s the turn of the European Systemic Risk Board (ESRB) to look into the risks generated by cryptocurrency. The European regulator in charge of financial stability has just published a report dedicated to the systemic implications of the crypto and the DeFi.

And, as in previous studies devoted to this issue, the balance sheet shows a limited risk to date. In its report, theESRB chaired by Christine Lagarde considers the impact on the financial system to be limited of the turbulence of 2022.

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Few significant links between TradFi and crypto, but…

The cryptocurrency market has few links with the traditional financial sector and the real economy, and none of these links are currently significant,” writes the ERSB’s Digital Assets and Decentralized Finance Taskforce.

From her analysis of the report, crypto finance and regulation expert Maha Al-Saadi draws a number of other lessons. These include DeFidescribed as a small market, disconnected from traditional finance.

The authors point out, however, that the means available to measure the size of DeFi are limited. However, this is not the only area where data is currently lacking to pinpoint the market for digital assets.

In the absence of specific regulatory data, it is difficult to identify investors in crypto-asset markets and direct risk bearers,” the paper notes.

Interconnections through stablecoins

Based on on-chain data, theESRB considers the exposure of European banks and funds to be minimal.

The reason why the authority is taking a close interest in this indicator is because it believes that “the links between crypto-assets and the traditional financial system could be an important channel for the transmission of shocks”.

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These interconnections are therefore key to understanding the risk of systemic crisis. From this state of play, however, “clear and growing links between crypto-assets and traditional finance” emerge.

These connections come about in particular through reserve-backed stablecoins. For these tokens, crypto players use traditional intermediaries.

From the ESRB’s point of view, the central question is how the crypto-asset market could become relevant from a systemic point of view.”

Crypto conglomerates in the crosshairs

The European supervisor is therefore assessing possible crisis situations. It also deems it necessary to “improve the ability of public authorities, including in the EU, to monitor potential contagion channels between the crypto-asset sector and the traditional financial sector”.

The report also looks at the risks associated with crypto conglomerates. In a speech at the World Bank Global Payments Week 2023Denis Beau, first Deputy Governor of the BdFalready mentioned this potential threat. The FTX bankruptcy and its impact demonstrate that it is not just theoretical.

This risk is also examined by the ESRB. It proposes policy options to deal with the risks arising from crypto conglomerates. However, this is not the only problem. The authors also cite leverageDeFi, staking and digital coin lending.

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