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FSB steps up investigation into DeFi risks

FSB steps up investigation into DeFi risks

The Financial Stability Board is stepping up its investigation into the opaque world of decentralised Finance (DeFi), fearful of the potential for spill over risks to traditional finance.

DeFi is commonly used to describe services in crypto-asset markets that aim to replicate some functions of the traditional financial system without the neeed for a middle man.

In a report to the G20, the FSB notes that while the processes to provide services are in many cases novel, DeFi does not differ substantially from traditional finance in the functions it performs or the vulnerabilities to which it is exposed.

However, states the FSB, the fact that crypto-assets underpinning much of DeFi lack inherent value and are highly volatile magnifies the impact of these vulnerabilities when they materialise, as recent chaos in the crypto markets bears out.

"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," states the FSB. "To date, these interlinkages are limited. However, if the DeFi ecosystem were to grow significantly, then the scope for spillovers would increase."

The FSB says it intends to carry out additional analysis of the growth and implications of the tokenisation of assets, as it could increase linkages between crypto-asset markets/DeFi, traditional finance and the real economy.

In addition, the Board will also explore approaches to fill data gaps to measure and monitor interconnectedness of DeFi, in collaboration with regulatory authorities.

The FSB’s proposed policy recommendations for the international regulation of crypto-asset activities may also need to be enhanced to acknowledge DeFi-specific risks and facilitate the application and enforcement of rules.

The FSB expects to publish its final crypto-asset regulatory framework in July 2023.

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