Influential political body warns that DeFi could shake the stability of the global financial system
The TradFi establishment has taken a long and hard look at DeFi. And he doesn’t like what he sees.
The Financial Stability Board (FSB), an international body that helps shape policy in the world’s largest countries, said yesterday that DeFi protocols could undermine trust in the global financial system.
While the FSB has been sounding the alarm about stablecoins for several years, the organization has only briefly focused on their use in DeFi dapps so far. The FSB fears that the lack of DeFi regulation and market oversight, systemic stablecoin risks, and cybersecurity breaches pose a serious threat.
“If the sector were to continue to grow in size, the crystallization of these vulnerabilities could have consequences for the functioning of and confidence in the broader financial system,” the FSB said in a statement. report published on February 16.
Unregulated financial services
The FSB report, titled Risk assessment for the financial stability of crypto-assetsdescribes DeFi as “a rapidly emerging industry” that provides “financial services using both unsecured crypto-assets and stablecoins… supposedly without the need for intermediaries.”
DeFi dapps are described as offering a wide range of “unregulated financial services” mimicking those offered by the legacy financial industry, including borrowing, lending, trading, insurance and derivatives products.
the FSB, which also includes the International Monetary Fund and the Bank for International Settlements, brings together top central bankers and finance ministers from the United States, Europe and major emerging economies. While acknowledging the innovative qualities of blockchain technology, the organization said decentralized governance poses a challenge for financial regulators. The report highlighted the absence of a single person or entity that could be held accountable for the operations of a project. Another concern is the lack of a clear legal jurisdiction overseeing global protocols or KYC procedures.
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The report also warns against third-party protocols offering “additional privacy enhancement” and even “law evasion techniques” to DeFi users. “It can therefore be difficult to trace transactions, which increases the risk that these platforms attract illegal activities, money laundering, financing of terrorism or circumvention of sanctions,” added the FSB.
However, the report questioned claims of decentralization, saying that projects “often exist along a spectrum of decentralization”. He cautions that founding teams often hold admin keys that allow them to make unilateral decisions about a dapp’s operations.
Cyber Security Breaches
also highlights the growing scale of DeFi hacks, warning that the concentration of capital in the industry’s major protocols increases the threat posed by cybersecurity breaches. The report estimates that DeFi protocols accounted for 75% of funds lost to hacks targeting the crypto industry in the first nine months of 2021.
The report also notes that the total value locked in DeFi far exceeds the sum raised by initial coin offerings (ICOs) between 2016 and 2019. With DeFi Llama estimating that $208.5 billion is currently locked in DeFi protocols, the sector currently represents six times the 35 billion dollars collected by ICOs.
The report argues that DeFi protocols have been a major catalyst for recent growth in stablecoin adoption, highlighting the perceived systemic risks between the two sectors.
The FSB describes “facilitating trading/lending/borrowing and acting as collateral in DeFi” as one of the three most common use cases for stablecoins. He warns that if a major stablecoin fails, “it is possible that liquidity within the broader crypto-asset ecosystem (including in DeFi) could become constrained, disrupting trading and potentially causing tensions in these markets”.
“The FSB and other standards bodies are already working to address the threats associated with so-called ‘global stablecoins,'” the report adds.