BIS Papers Discuss Risks in Crypto Markets and Decentralized Finance
The Bank for International Settlements (BIS) published papers on addressing the risks in crypto-asset markets and on the technology of decentralized finance.
Paper on Risks in Crypto Markets. The paper discusses the recent high-profile failures of FTX and other crypto firms and highlights the need for appropriate policy response to address the risks in crypto, including through regulation. The paper identifies that “shadow financial” functions enabled by crypto markets share many of the vulnerabilities of traditional finance. These relate to high leverage, liquidity and maturity mismatches, and substantial information asymmetries. The paper sets out three—non-mutually exclusive—lines of actions to address the risks in crypto. The first option involves banning the crypto activities, either in their entirety or in a targeted manner. The second option is to isolate and contain crypto so that it remains a niche activity while the third option is to regulate crypto in a way similar to traditional finance. This approach would require authorities to map activities performed in crypto markets to traditional finance and then use similar guiding principles to regulate crypto, combining activity and entity-based approaches. This approach would ensure consistency in regulating financial activities—whether performed by crypto players or traditional finance—and help to promote the policy goals at the core of existing regulatory frameworks. It would allow responsible actors to innovate with regulatory compliance and oversight. The paper also outlines complementary lines of policy action to address inefficiencies in traditional finance and curb the demand for crypto, such as encouraging sound innovation with central bank digital currencies (CBDCs) and improving the quality and reducing the costs of payments. The online appendix to the paper provides a selective overview of ongoing initiatives in crypto regulation.
Paper on Decentralized Finance or DeFi. The paper provides a deep dive into the overall architecture, the technical primitives, and the financial functionalities of decentralized finance protocols. The paper analyzes and explains the individual components and how they interact through the lens of a decentralized finance stack reference model featuring three layers: settlement, applications, and interfaces. The settlement layer is responsible for completing financial transactions and discharging obligations. The application layer comprises applications implemented through smart contracts, thus combining crypto-assets, decentralized finance protocols, and compositions. The interface layer provides front-end interfaces that facilitate user-friendly interaction with the smart contract logic. The paper also describes financial services for the most relevant decentralized finance categories—that is, decentralized exchanges, lending protocols, derivatives protocols, and aggregators—and reviews how decentralized finance protocols can be combined into compositions. Finally, the paper outlines an interdisciplinary agenda for future research, focusing on understanding systemic risk more profoundly by analyzing token flows and protocol dependencies, both within the crypto-ecosystem and by considering the potential spillovers from and to the traditional financial system.
Related Links
Keywords: International, Banking, Cryptoassets, Regtech, Decentralized Finance, CBDC, Central Bank Digital Currencies, Liquidity Risk, DeFi, Lending, Credit Risk, Derivatives, BIS
Previous Article
FSB Assesses Progress Toward NBFI Reforms, Issues Other UpdatesNext Article
Dubai FSA Outlines Business Plan for 2023-2024Related Articles
FINMA Approves Merger of Credit Suisse and UBS
The Swiss Financial Market Supervisory Authority (FINMA) has approved the takeover of Credit Suisse by UBS.
BOE Sets Out Its Thinking on Regulatory Capital and Climate Risks
The Bank of England (BOE) published a working paper that aims to understand the climate-related disclosures of UK financial institutions.
OSFI Finalizes on Climate Risk Guideline, Issues Other Updates
The Office of the Superintendent of Financial Institutions (OSFI) is seeking comments, until May 31, 2023, on the draft guideline on culture and behavior risk, with final guideline expected by the end of 2023.
APRA Assesses Macro-Prudential Policy Settings, Issues Other Updates
The Australian Prudential Regulation Authority (APRA) published an information paper that assesses its macro-prudential policy settings aimed at promoting stability at a systemic level.
BIS Paper Examines Impact of Greenhouse Gas Emissions on Lending
BIS issued a paper that investigates the effect of the greenhouse gas, or GHG, emissions of firms on bank loans using bank–firm matched data of Japanese listed firms from 2006 to 2018.
HMT Mulls Alignment of Ring-Fencing and Resolution Regimes for Banks
The HM Treasury (HMT) is seeking evidence, until May 07, 2023, on practicalities of aligning the ring-fencing and the banking resolution regimes for banks.
MFSA Sets Out Supervisory Priorities, Issues Reporting Updates
The Malta Financial Services Authority (MFSA) outlined its supervisory priorities for 2023
German Regulators Issue Multiple Reporting Updates for Banks
Deutsche Bundesbank published the nationally deactivated validation rules for the German Commercial Code (HGB) users on the taxonomy 3.2, which became valid from December 31, 2022
BCBS Report Examines Impact of Basel III Framework for Banks
The Basel Committee on Banking Supervision (BCBS) published results of the Basel III monitoring exercise based on the June 30, 2022 data.
PRA Consults on Prudential Rules for "Simpler-Regime" Firms
Among the recent regulatory updates from UK authorities, a key development is the first-phase consultation, from the Prudential Regulation Authority (PRA), on simplifications to the prudential framework that would apply to the simpler-regime firms.
