ESMA Report on Decentralized Finance (DeFi): Potential Benefits and Significant Risks
Summary:
The European Securities and Markets Authority (ESMA) published a report detailing the benefits and risks of Decentralized Finance (DeFi) in the EU market. The report notes that despite potential advantages such as financial inclusion, innovative financial products development, and enhanced transaction efficiency, DeFi carries significant risks, including liquidity risk, potential smart contract errors, and vulnerability to scams due to the lack of know-your-customer protocols. However, DeFi and cryptocurrencies do not currently present considerable threats to financial stability, based on their small scale and limited interaction with traditional financial markets.
On October 11, the European Union's financial markets overseer, the European Securities and Markets Authority (ESMA), published a comprehensive review on Decentralized Finance (DeFi) and its associated risks within the EU marketplace. Stretching across 22 pages, the report acknowledges the potential advantages of DeFi, such as improved financial access, the creation of advanced financial products, and the augmentation of the safety, speed, and affordability of financial transactions. Nevertheless, ESMA also outlines the “notable risks” attached to DeFi. It stipulates that the foremost risk is related to the liquidity of numerous high-risk and volatile digital assets. The agency equates the 30-day volatility of Bitcoin or Ether to the Euro Stoxx 50, stating that the former's volatility is, on average, 3.6 and 4.7 times higher than the latter's. ESMA asserts that, contrary to expectations, DeFi has not successfully mitigated counterparty risk via smart contracts and atomicity, as smart contracts can also be subject to errors and defects. The report also emphasizes that DeFi is particularly susceptible to scams and illegal activity owing to the lack of adhere to know-your-customer (KYC) procedures. A further risk to DeFi users, detailed in the report, is the unavailability of a clear accountable entity and the lack of a rectification procedure. However, the report clarifies that at present, DeFi and cryptocurrencies are not major threats to financial stability due to their modest scale and the little crossover between digital and traditional financial marketplaces. ESMA maintains rigorous monitoring of the cryptocurrency market and issued its second consultative document on Markets in Crypto-Assets (MiCA) obligations on October 5. Through a thorough 307-paged text, the overseer proposed allowing crypto service providers to retain transaction data in their preferred format, provided it can be transformed into a particular format upon official request.
Published At
10/11/2023 10:12:37 AM
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