The G20 Financial Stability Board said on Thursday it would take steps to address “vulnerabilities” and data gaps in decentralized finance highlighted by the failure of exchange FTX last year.
The rapidly growing and unregulated decentralized finance (known as DeFi) segment offers cryptocurrency asset trading, lending and borrowing services by using public blockchains to record transactions, without central control.
“The fact that the crypto-assets that underpin much of DeFi lack inherent value and are highly volatile magnifies the impact of these vulnerabilities when they materialize, as recent incidents demonstrate,” the Financial Stability Board (FSB) said in a report to ministers from the Group of 20 (G20) major economies meeting next week.
FSB member countries will now “proactively” analyze DeFi vulnerabilities as part of regular monitoring of cryptocurrency markets, according to the report.
“Possible policy responses may include, for example, regulatory and supervisory requirements regarding direct exposures of traditional financial institutions to DeFi,” the report states.
The FTX debacle that took place last November exposed the vulnerabilities of intermediaries and DeFi, according to the report.
“The full extent of the impact of this bankruptcy, including on DeFi projects owned or dependent on FTX for trade flows, will take time to become apparent, given the lack of disclosure and transparency in these markets,” the report said.
GAPS IN MONITORING
The most worrisome vulnerability of DeFi is related to liquidity “mismatches” arising from different maturities of liabilities and assets, according to the report.
Some DeFi agreements may be “deliberately” cross-border to exploit gaps in oversight, hence the need for international coordination, he added.
Until the sharp fall in the prices of the Bitcoin and the FTX crash, regulators had largely focused on crypto assets and not related technology.
The FSB said it would also study the tokenization — or digital representation — of real assets, which could increase the links between cryptocurrency and DeFi markets with the financial system and the broader economy.
The FSB’s existing recommendations to regulate crypto assets may need to be improved to hedge DeFi risks, according to the report.
Members of the Financial Stability Board will also consider how DeFi activities could be included in existing standards for conventional finance.
“If DeFi activities and entities are considered to fall within the regulatory perimeter, compliance with applicable regulations is ensured,” the report states.
For DeFi activities that fall outside the existing rules, new standards may be needed.