ESRB on Crypto Impact and DeFi: Analyzing the Need for Tighter Regulation and Surveillance

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The European Systemic Risk Board (ESRB) has recently stated that despite a volatile year for cryptocurrency, its impact on traditional financial systems has been relatively minimal. However, the board has advised caution and urges for closer supervision of this growing financial sector. The European Central Bank (ECB) has previously pushed for immediate regulations to mitigate potential systemic risks emanating from cryptocurrencies.

A step forward has been made as European lawmakers responded through the Markets in Crypto Assets or MiCA regulation in April, which established standards for stablecoin regulation and crypto oversight. However, the ESRB suggests that there is a need for additional work in this area.

The ESRB, which is closely linked with the ECB, also highlighted the importance of maintaining surveillance in the realms of Decentralized Finance (DeFi) and smart contracts. These areas, according to the board, currently fall short of MiCA’s mandate.

Considering the rapid growth trajectory and uncertain future of the cryptocurrency markets, potential systemic risks should not be disregarded, as mentioned in the report. These threats could emerge if interconnectedness with traditional financial systems increases over time.

While the DeFi market may be considered “very small” at the moment, the report’s recommendations include several changes to quell existing regulatory concerns, such as requiring regular reporting by financial institutions with cryptocurrency exposure.

Gasper Stih, marketing director at ZondaCrypto, noted that while the ESRB report’s tone may have changed from previous years, it maintains a similar overarching theme. By acknowledging the relatively small size of the DeFi market, the ESRB may be underestimating the rapid expansion in the crypto and DeFi spaces.

To identify and address potential systemic risks stemming from these areas, the ESRB suggests promoting EU-level knowledge exchange and monitoring of market developments. This would include a focus on operational resilience, DeFi, digital asset staking, and lending activity. The purpose is to identify, assess, and mitigate potential risks to financial stability and macroprudential policy effectiveness.

According to Stih, it is essential to focus on reducing manipulation and exploitation of cryptocurrencies and DeFi, as they continue to cause undue volatility in the market. However, striking the right regulatory balance will be crucial in ensuring the growth of the sector while maintaining a secure environment for investors and other stakeholders.

Source: Blockworks

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