Global Financial Watchdog Zeroes in on DeFi
Global financial watchdog FSB is looking to adopt measures to address vulnerabilities and data gaps seen in the fast-growing DeFi space, the authority said in a report issued on Thursday. The regulator argues that digital assets underpinning DeFi “lack inherent value” and are significantly volatile.
DeFi Assets “Lack Inherent Value,” Says FSB
International regulator Financial Stability Board (FSB) issued a report to ministers from the Group of 20 (G20) nations, announcing its plan to take measures to address shortcomings and data gaps in decentralized finance (DeFi). The move comes amid growing risks posed by the rapidly-growing and unregulated DeFi space highlighted by several collapses in the crypto industry last year.
“The fact that crypto-assets underpinning much of DeFi lack inherent value and are highly volatile magnifies the impact of these vulnerabilities when they materialize, as recent incidents demonstrate.”– the report states.
The report adds that FSB’s member countries will “proactively” assess DeFi vulnerabilities as part of regular monitoring of the crypto markets. The regulator hinted at potential policy responses such as “regulatory and supervisory requirements concerning traditional financial institutions’ direct exposures to DeFi.”
The report mentions vulnerabilities exposed by the far-reaching collapse of the crypto exchange FTX in November 2022, with its contagion impact still spreading. FSB said the full extent of the impact on FTX-owned DeFi projects and the broader crypto space would take time to become evident due to low disclosure and transparency in these markets.
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FSB Cites Liquidity Mismatches as DeFi’s Biggest Vulnerability
While DeFi offers numerous innovative services, the sector is not significantly different from traditional finance (TradFi) in its functions, the FSB noted in the report. In fact, by attempting to replicate some TradFi features, DeFi amplifies potential risks due to its use of novel technologies, high level of ecosystem interlinkages, and poor regulation and compliance. Furthermore, the regulator argued that the extent of decentralization in DeFi “deviates substantially” from the popular claims.
The report said the most troubling shortcoming in DeFi is related to “mismatches” in liquidity from different maturities in liabilities and assets. Some arrangements in this sector could be cross-border on purpose to exploit vulnerabilities in supervision.
A recent research report by TRM Labs showed that DeFi accounted for 80% of all crypto hacks in 2022, through which the attackers stole a record $3.7 billion. As a result, several global regulators shifted their focus to DeFi, including the European Commission.
Do you think tighter DeFi regulation could impede the sector’s future growth? Let us know in the comments below.