The European Securities and Markets Authority (ESMA) stated in a report that decentralized finance (DeFi) is yet to pose a meaningful risk to overall financial stability but emphasized the need for monitoring. The report titled "Decentralized Finance in the EU: Developments and Risks" acknowledged the benefits and risks associated with DeFi, noting its relatively small size in comparison to traditional financial markets. While DeFi's total value locked (TVL) is around $40 billion, the total assets of financial institutions in the EU amounted to approximately $90 trillion in 2021.


European Regulator: DeFi Yet to Pose Financial Stability Risk but Requires Monitoring


The European Securities and Markets Authority (ESMA) stated in a report that decentralized finance (DeFi) is yet to pose a meaningful risk to overall financial stability but emphasized the need for monitoring. The report titled "Decentralized Finance in the EU: Developments and Risks" acknowledged the benefits and risks associated with DeFi, noting its relatively small size in comparison to traditional financial markets. While DeFi's total value locked (TVL) is around $40 billion, the total assets of financial institutions in the EU amounted to approximately $90 trillion in 2021.


According to the report, the crypto-assets markets, including DeFi, do not represent meaningful risks to financial stability at this point due to their relatively small size and limited contagion channels between crypto and traditional financial markets. The total crypto market capitalization is just over $1 trillion, constituting about 3.2% of the total assets held by EU banks.


The report acknowledged several crypto contagions in 2022, such as the collapse of the Terra ecosystem and FTX, but noted that these incidents had no meaningful impact on traditional markets. Despite the current limited impact, the regulator highlighted that DeFi shares traits and vulnerabilities with traditional finance, such as liquidity and maturity mismatches, leverage, and interconnectedness.


ESMA cautioned that while investors' exposure to DeFi remains small, there are serious risks to investor protection due to the highly speculative nature of many DeFi arrangements, operational and security vulnerabilities, and the lack of a clearly identified responsible party. The regulator emphasized the importance of monitoring DeFi, suggesting that if the phenomenon were to gain significant traction or if interconnections with traditional financial markets were to become material, it could translate into systemic risks.


(MARTIN YOUNG, COUNTELEGRAPH, 2023)