The European Systemic Risk Board (ESRB) has recently turned its attention to crypto and decentralised finance (DeFi). In a report compiled by its Crypto-Assets and Decentralised Finance (CATF) task force, the organisation takes a closer look at the systemic implications of the crypto asset market on traditional finance, and proposes priorities in policy making for mitigating potential issues.

With the value of crypto assets estimated at just 0.8 percent of the EU’s financial sector and the observation that “the crypto asset world has had few links with, and provided few services to the real economy, none of them vital”, the report concludes that the crypto asset market and DeFi applications currently have limited systemic implications on the EU’s financial sector. However, it cautions against assuming that this status quo would always remain. Based on the “rapid growth trends observed in recent years”, systemic risks could appear “quickly and suddenly” to rock the region’s financial stability.

An unpredictable space

ESRB admits that at the present moment, it is difficult to estimate how long crypto assets and DeFi will take to rise to systemic prominence. The space is rapidly developing and unpredictable, which is why the organisation advises against relying heavily on current observations to guide policy. Nevertheless, the report discusses three possible scenarios that could lead to the increased relevance of crypto and DeFi in the finance sector:

• A run on a stablecoin
• Greater integration between the crypto asset and traditional finance worlds
• A major expansion in transacting with crypto assets instead of traditional means of payment

Getting priorities right

ESRB expects that existing policies, such as Markets in Crypto Assets (MiCA), will do the job of safeguarding market integrity, financial stability, and consumers to a certain extent. The paper proposes the outcomes that new policies should prioritise with this in mind.

The priorities, listed in order of urgency and importance, are as follow:

• Improve the EU’s capacity to monitor potential contagion channels between the crypto asset sector and the traditional financial sector, as well as within the crypto asset sector.
• Carry out assessments of risks posed by: (a) crypto conglomerates, taking into account market developments following the application of MiCA, and (b) leverage using crypto assets, and identify potential additional actions to mitigate observed risks.
• Promote EU-level knowledge exchange and monitoring of market developments, focusing on the following areas where risks may emerge, notably relating to: (a) operational resilience, (b) DeFi, and (c) crypto asset staking and lending.

Read the full report here.