European regulator: DeFi comes with significant risks as well as benefits

The European Securities and Markets Authority published an article about decentralized finance and the threats it poses to the EU market. On October 11, the European Securities and Markets Organisation (ESMA), the EU’s financial markets supervisory organization, published an essay on decentralized finance (DeFi) and the threats it poses to the EU market.  In a 22-page analysis, the ESMA acknowledges the anticipated benefits of DeFi, such as increased financial inclusion, the development of novel financial products, and the improvement of the speed, security, and cost of financial transactions. The research does, however, emphasize the “significant risks” of DeFi. The first is liquidity risk, which is linked to the extremely speculative and volatile nature of many crypto assets, according to the ESMA. 

The authority compares Bitcoin’s 30-day volatility to that of the Euro Stoxx 50 index, with cryptocurrencies being 3.6 and 4.7 times more volatile than the stock index, respectively. The ESMA does not believe that DeFi can prevent counterparty risk, even if smart contracts and atomicity should reduce or eliminate it. Smart contracts, however, are not immune to faults or weaknesses. According to the ESMA, DeFi is especially prone to scams and illegal activity since it lacks Know Your Customer (KYC) requirements. According to the paper, another significant source of danger for DeFi users is the lack of an identifiable accountable party and the absence of a redress mechanism. This is due to their small size and the low interconnection of crypto and traditional financial markets. The ESMA is keeping a close eye on the crypto sector, issuing its second consultative paper on the Markets in Crypto-Assets legislation on October 5. The regulator advised in the 307-page document that crypto asset providers retain transaction data in “the format they consider most appropriate,” assuming they can convert it into a designated format if authorities want it.

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