Europe’s Systemic Risk Board Raises Alarm Over Crypto and DeFi

The European Systemic Risk Board (ESRB) said Thursday despite a volatile year for crypto, its effect on traditional financial systems has been minimal. Even so, the board still cautioned for further oversight.

This marks a slight shift in urgency, where the European Central Bank (ECB) has previously called for immediate regulations to curb systemic risks posed by crypto.

While European lawmakers eventually answered the call via the Markets in Crypto Assets or MiCA regulation in response in April — which set standards for stablecoin regulation and crypto oversight — more legwork is required, the ESRB said.

The ESRB is closely linked with the ECB, providing secretarial and logistical support with the bank’s president, Christine Lagarde, serving as the board’s chair.

In a report published Wednesday, the financial watchdog stressed the need for continued surveillance, namely around DeFi and smart contracts, which fall short of MiCA’s mandate.

Given the impressive growth trajectory and unpredictable future of crypto markets, the potential systemic risks cannot be dismissed, the report reads.

“These risks could materialize if, for example, interconnectedness with the traditional financial system increases over time,” it said.

For now crypto posed no such risks following a rout in the industry last year, the ESRB said.

Still, the report recommends policymakers implement several changes to quell existing regulatory concerns. Those include regular reporting requirements for financial institutions with crypto exposure. 

Gasper Stih, marketing director at ZondaCrypto, told Blockworks that while the report’s language and message differs somewhat from years past, the ESRB is maintaining a similar theme.

While the report attempts to give the impression of overarching systemic risk, it also acknowledges the DeFi market as being “very small.”

“This seems to indicate that any threat perceived by the ECB is one that only exists some way into the future, hinting at a possibility that the board may be underestimating the speed at which the crypto and DeFi market typically progresses,” Stih said.

A short-term fix

The ERCB stressed the need to identify and address systemic risks stemming from these areas, suggesting that the potential for prudential, reputational or operational risks could be magnified. 

As such, the ESRB recommended promoting EU-level knowledge exchange and monitoring of market developments. This includes a particular focus on operational resilience, DeFi and digital asset staking, and lending activity.

The intent, they say, is to identify, assess and mitigate potential risks to financial stability and the effectiveness of macroprudential policy. 

Though that shouldn’t be the only area of focus, Stih said.

“What’s more important going forward is a focus on reducing manipulation and exploitation of crypto and DeFi, as these remain key factors that continue to cause undue volatility in the market.”

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