The Financial Stability Board (FSB) has intensified its scrutiny of Decentralised Finance (DeFi), expressing apprehension over the potential spill-over risks it poses to traditional finance. DeFi refers to a set of services in crypto-asset markets that aim to replicate some functions of the conventional financial system without the intervention of intermediaries.

As the FSB submitted a report to the G20, it observed that while the services that DeFi provides are innovative, they do not differ substantially from conventional finance regarding the functions it carries out or the vulnerabilities it is exposed to. However, the FSB noted that the lack of inherent value and high volatility of crypto-assets that support much of DeFi magnify the impact of these vulnerabilities when they emerge, as seen in the recent turmoil in the crypto markets.

Interlinkages and Transmission Channels

The FSB has stated that the extent of these vulnerabilities leading to financial stability concerns largely depends on the interlinkages and transmission channels between DeFi, traditional finance, and the real economy. While these interlinkages are currently limited, the FSB is concerned that the scope for spillovers could increase significantly as the DeFi ecosystem grows.

Tokenisation of Assets

The FSB plans to conduct further analysis of the growth and implications of asset tokenisation, as it could increase linkages between crypto-asset markets/DeFi, traditional finance, and the real economy. Additionally, the Board will collaborate with regulatory authorities to explore approaches to fill data gaps to measure and monitor interconnectedness of DeFi.

Policy Recommendations

The FSB's proposed policy recommendations for the global regulation of crypto-asset activities may need to be enhanced to recognise DeFi-specific risks and facilitate the implementation and enforcement of regulations. The Board expects to publish its final crypto-asset regulatory framework in July 2023.

Conclusion

The FSB's intensified investigation into DeFi reflects growing concerns over the potential impact of decentralised finance on traditional finance and the real economy. The FSB's report highlights that the risks to financial stability depend on the extent of the interlinkages and transmission channels between DeFi and other financial systems. With DeFi's ecosystem poised for significant growth, the FSB's efforts to measure and monitor the interconnectedness of DeFi and enhance regulatory frameworks specific to DeFi are crucial steps towards mitigating systemic risks in the financial markets.