A new Bank of International Settlements (BIS) paper has called for “tailored regulatory interventions” along with a new prudential framework to manage emergent systemic risks in the crypto and decentralised finance (DeFI) worlds.
The just-published report argues that while DeFI and crypto have primarily served as speculative vehicles, the blockchain-based markets have become increasingly entangled with traditional finance even though links to real world economies remain “very limited”.
Global bodies such as the BIS and national regulators have been “more proactive in defining policies to respond to the growth of crypto and DeFi”.
Despite the revolutionary claims of some fintech absolutists, the paper says the underlying DeFI functions map closely to traditional finance intermediaries, suggesting current regulations would apply in many cases.
However, DeFI “poses significant challenges, including new forms of information asymmetries, market inefficiencies and the risk of cryptoisation in emerging markets”, the BIS paper says, which likely require special regulatory attention.
Authorities have, to date, fallen into three main camps on how to respond to the challenge, labelled as ‘ban, contain or regulate’ in the report.
But the ‘Cryptocurrencies and decentralised finance: functions and financial stability implications’ paper says a ban is neither feasible nor “desirable because there are indeed aspects of crypto and DeFi that represent useful innovation”.
In particular, the report – authored by BIS contributors Matteo Aquilina, Giulio Cornelli, Jon Frost and Leonardo Gambacorta – says regulators should focus on potential DeFI systemic risks in banking and insurance.
As well, the paper highlights ‘stablecoins’ (or digital tokens backed by traditional financial assets), ‘decentralised protocols’ and the macro-economic risks of mass crypto adoption in emerging markets as key regulatory focus areas.
The BIS study also cites evidence that “retail investors have systemically lost out relative to wealthier investors” via crypto-trading markets.
“This implies that the crypto market, which is often presented as an opportunity for inclusive growth and financial stability, can be a means for redistributing wealth from the poorer to the wealthier,” the report says.