Although the last year has been turbulent for the crypto and decentralized finance (DeFi) market, the impact on the financial system has been limited, according to a report by the European Systemic Risk Board (ESRB) on the digital financial sector and the systemic impact of cryptos.
As the Board says, the crypto market has few linkages with the traditional financial sector and the real economy and none of the linkages are significant.
However, given the exponential growth and high volatility of cryptocurrencies, these markets should be closely monitored as they may pose systemic risks, the Council warns.
These risks could arise if, for example, interconnectedness with the traditional financial system increases over time, new connections are not detected in time, or if similar innovations – such as distributed ledger technology – are widely adopted in traditional finance.
To better understand developments in crypto and the potential implications for financial stability, the Council proposes a number of options:
First, the EU’s ability to monitor potential transmission channels should be improved. This applies both to channels between crypto and traditional finance and to channels within the crypto market. To this end, it is important to promote standardized reporting and disclosure requirements for:
- traditional financial sector institutions, such as banks exposed to crypto
- investment funds with crypto exposures; and
- entities such as stablecoin issuers or e-wallet service providers
Second, the report examines policy options to address the risks posed by crypto firms and groups, crypto leverage, new business challenges, decentralized finance, and crypto betting and lending.
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