On 16 February 2023, the Financial Stability Board (FSB) published a report on the financial stability risks of decentralised finance (DeFi).
The report describes DeFi as an umbrella term commonly used to describe a variety of services in crypto-asset markets that are intended to replicate some functions of the traditional financial system by seemingly disintermediating their provision and decentralising their governance. In DeFi, the role of financial institutions and market infrastructures is replaced to varying degrees by self-executing code, or so-called smart contracts, deployed to public blockchains. DeFi emerges primarily as a crypto-based alternative and competitive peer-to-peer/pool marketplace of financial services, covering various activities like trading, borrowing, or lending, so far overwhelmingly within the crypto-asset space.
The report finds 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. DeFi’s specific features may result in some of these vulnerabilities- such as operational fragilities, liquidity and maturity mismatches, leverage and interconnectedness – playing out at times differently than in traditional finance. Furthermore, 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.
Based on these findings, the FSB will carry out additional work to:
- Analyse the growth and implications of the tokenisation of assets, i.e. the creation of a digital representation (token) of a financial instrument or real asset, as it could increase linkages between crypto-asset markets/DeFi, traditional finance and the real economy.
- Explore approaches to fill data gaps to measure and monitor the interconnectedness of DeFi, in collaboration with standard-setting bodies (SSBs) and regulatory authorities.
- Examine the extent to which the FSB’s proposed policy recommendations for the international regulation of crypto-asset activities may need to be enhanced to acknowledge DeFi-specific risks and facilitate the application and enforcement of rules.
- Consider, in coordination with the SSBs, the regulatory perimeter across jurisdictions to determine which DeFi activities and entities fall or should fall within that perimeter. It also includes considering whether to subject such entities to additional prudential and investor protection requirements or to step up enforcement of existing requirements.