The G20’s Financial Stability Board (FSB) said on Thursday it would take steps to tackle “vulnerabilities” and data gaps in decentralised finance (DeFi) highlighted by the collapse of cryptocurrency exchange FTX last year.
The fast-growing and unregulated DeFi segment offers trading, borrowing and lending in cryptocurrency assets by using public blockchains to record transactions, with no central control.
“The fact that crypto-assets underpinning much of DeFi lack inherent value and are highly volatile magnifies the impact of these vulnerabilities when they materialise, as recent incidents demonstrate,” the FSB said in a report to ministers from the Group of 20 (G20) major economies meeting next week.
FSB member countries will now “proactively” analyse vulnerabilities from DeFi as part of regular monitoring of crypto markets, the report said.
“Potential policy responses may include, for example, regulatory and supervisory requirements concerning traditional financial institutions’ direct exposures to DeFi,” it said.
The collapse of FTX last November exposed vulnerabilities in intermediaries and DeFi, the report said.
“The full extent of the impacts of this failure, including on DeFi projects that were owned by FTX or depended on it for trading flows, will take time to become apparent given the lack of disclosure and transparency in these markets,” the report said.
Supervision gaps
The most worrying vulnerability in DeFi relates to “mismatches” in liquidity from different maturities in liabilities and assets, the report said.
Some DeFi arrangements may be “purposefully” cross-border to exploit gaps in supervision, hence the need for international coordination, it added.
Until the sharp retreat in bitcoin prices and the FTX crash, regulators had largely focused on cryptoassets rather than related technology.
The FSB said it would also study the tokenisation – or digital representation – of real assets which could increase links between crypto markets and DeFi with the wider financial system and economy.
The FSB’s existing recommendations for regulating cryptoassets may need to be enhanced to cover risks from DeFi, the report said.
FSB members will also study how DeFi activities could come under existing rules for mainstream finance.
“If DeFi activities and entities are deemed to fall within the regulatory perimeter, the enforcement of compliance with applicable regulations is warranted,” the report said.
For DeFi activities outside existing rules, new policies could be needed, it said.
© Thomson Reuters 2023