FSB to Step Up DeFi Analysis

The Financial Stability Board (FSB) has published a new report on the financial stability risks from decentralised finance (DeFi) and says it will commence additional work to analyse the risks associated with the model as well as seek to better understand the regulatory scope required for effective oversight.

The report, which was delivered to the February G20 finance ministers and central bank governors meeting, concludes 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.

The FSB says that 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. “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, as recent incidents demonstrate,” it states.

The extent to which these vulnerabilities can lead to financial stability concerns largely depends on the interlinkages and transmission channels between DeFi, traditional finance and the real economy, FSB observes. To date, it says, these interlinkages are limited, “However, if the DeFi ecosystem were to grow significantly, then the scope for spillovers would increase.”

As a result of the report FSB says it will analyse the growth and implications of the tokenisation of assets, as it could increase linkages between crypto-asset markets/DeFi, traditional finance and the real economy. It will also explore approaches to fill data gaps to measure and monitor interconnectedness of DeFi, in collaboration with standard-setting bodies (SSBs) and regulatory authorities.

The regulator’s additional work will also examine the extent to which its 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.

Finally, the FSB says it will 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. This includes considering whether to subject such entities to additional prudential and investor protection requirements or to step up enforcement of existing requirements.

The full report can be accessed here.