FSB Report Assesses Financial Stability Risks of Decentralized Finance
The Financial Stability Board (FSB) published a report that examines the financial stability risks of decentralized finance (DeFi). The report analyzes the decentralized finance ecosystem, identifies vulnerabilities associated with decentralized finance, and outlines work to be done to address these vulnerabilities.
The report highlights that, within the crypto-asset ecosystem, decentralized finance (DeFi) has emerged as a fast-growing segment. Decentralized finance is an umbrella term commonly used to describe a variety of services in crypto-asset markets that aim to replicate some functions of the traditional financial system (TradFi) while seemingly disintermediating their provision and decentralizing their governance. This report, which was delivered to the February G20 Finance Ministers and Central Bank Governors meeting, concludes that decentralized finance does not differ substantially from traditional finance in the functions it performs or in terms of the vulnerabilities to which it is exposed; however, the processes to provide such services are in many cases novel. These vulnerabilities associated with decentralized finance include operational fragilities, liquidity and maturity mismatches, leverage, and interconnectedness. The report highlights that the extent to which these vulnerabilities can lead to financial stability concerns largely depends on the interlinkages and transmission channels between decentralized finance, traditional finance, and the real economy. These interlinkages have so far been limited, as shown by the modest impact of the May/June 2022 crypto-asset market turmoil and the November 2022 FTX collapse on traditional finance.
However, if the decentralized finance ecosystem were to grow significantly and become more mainstream, as a result of the broader adoption of crypto-assets and the development of real-world use cases, then interlinkages would deepen and the scope for spillovers to traditional finance and the real economy would increase. Based on these findings, FSB will conduct additional work to:
- analyze the growth and implications of the tokenization of assets—that is, the creation of a digital representation (token) of a financial instrument or real asset—as it could increase linkages between crypto-asset markets/decentralized finance, traditional finance, and the real economy.
- explore approaches to fill data gaps to measure and monitor the interconnectedness of decentralized finance with traditional finance, with the real economy, and with the crypto-asset ecosystem, in collaboration with standard-setting bodies and regulatory authorities.
- examine the extent to which the FSB-proposed policy recommendations for the international regulation of crypto-asset activities may need to be enhanced to acknowledge decentralized finance-specific risks and facilitate the application and enforcement of rules.
- assess the regulatory perimeter across jurisdictions, in coordination with the standard-setting bodies, to determine which decentralized finance activities and entities fall or should fall within that perimeter.
- possibly consider whether to subject such decentralized finance entities to additional prudential and investor protection requirements or to step up enforcement of the existing requirements.
FSB and the standard-setting bodies can play an important role in such perimeter assessments as well as in strengthening cross-border cooperation and data-sharing. FSB is well-placed to analyze and advise on cross-sectoral and cross-border issues, including how to promote effective cooperation with respect to crypto-asset supervision and regulation.
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Keywords: International, Banking, Regtech, Decentralized Finance, Financial Stability, Systemic Risk, Fintech, Tokenization, Crypto-Assets, Blockchain, FSB
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