The European Securities and Markets Authority (ESMA), the supervisory authority for the financial markets of the European Union, released an article on decentralized finance (DeFi) and the risks they pose to the EU market on October 11.
In a 22-page report, ESMA acknowledges the promised benefits of DeFi, such as greater financial inclusion, the development of innovative financial products, and improving the speed, security, and costs of financial transactions.
However, the document also highlights the โsignificant risksโ of DeFi. According to ESMA, the first is the liquidity risk linked to the highly speculative and volatile nature of many crypto assets. The authority compares Bitcoin's 30-day volatility (btc) and ether (ETH) with the Euro Stoxx 50 index, with cryptocurrencies, on average, 3.6 and 4.7 times higher than the stock market index.
ESMA does not believe that DeFi will manage to avoid counterparty risk, although, in theory, it should be lower or even non-existent due to smart contracts and atomicity. However, smart contracts are not immune to errors or failures.
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DeFi is especially vulnerable to scams and illicit activities as it lacks Know Your Customer (KYC) protocols. Another major source of risk for DeFi users, as specified in the report, is the lack of an identifiable responsible party and the absence of a recourse mechanism.
But at this point, DeFi and cryptocurrencies in general do not pose โsignificant risksโ to financial stability, the report concludes. This is due to its relatively small size and limited interconnection between traditional financial markets and cryptocurrencies.
ESMA pays close attention to the cryptocurrency market and publishes its Second consultation document on the mandates of the cryptoasset markets (MiCA). 5th of October. In a 307-page document, the regulator suggested allowing cryptoasset providers to store transaction data in "the format they consider most appropriate," if they can convert it to a specific format if requested by authorities.
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