DeFi comes with great risks and benefits
The European Securities and Markets Authority (ESMA) – the European Union's financial markets regulatory authority – has published an article on decentralized finance (DeFi) and its potential risks to the EU market on October 11.
In a 22-page report, ESMA acknowledged DeFi's promised benefits of financial inclusion, the development of innovative financial products and the speed, security and costs of financial transactions.
However, the paper highlights the “significant dangers” of Defy. According to ESMA, the first liquidity risk is related to the highly speculative and volatile nature of many crypto assets. The authority compared the 30-day volatility of Bitcoin (BTC) and Ether (ETH) to the Euro Stoxx 50 index, where the cryptocurrencies averaged 3.6 and 4.7 times the stock index.
ESMA does not believe that DeFi eliminates counterparty risk, even though it is low or non-existent due to the concept, smart contracts and simple contracts. However, smart contracts are not free from errors or flaws.
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DeFi is particularly vulnerable to fraud and illegal activities as it lacks Know Your Customer (KYC) protocols, according to ESMA. Another important source of risk for DeFi users, as noted in the report, is the absence of an identifiable responsible party and lack of a recourse mechanism.
However, currently DeFi and crypto in general do not represent “meaningful threats” to financial stability, the report concludes. This is due to their relatively small size and limited correlation between crypto and traditional financial markets.
The ESMA pays a lot of attention to the crypto market, the second consultation paper on crypto-assets regulations on markets on October 5. In the 307-page document, the regulator proposed that crypto asset providers store transaction data in a “format”. They consider it the most appropriate, “If they can convert it to a certain format, they should ask the authorities to ask for it.”
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