- The BIS has drawn the attention of investors to the dangers affiliated with the growing field of cryptocurrencies.
- DeFi in particular was the focal point of the warning by the Bank For International Settlements.
- According to DeFi proponents, the ecosystem grew to solve the problems associated with traditional financial institutions.
The Bank For International Settlements (BIS) has released its latest quarterly review, calling for the regulation of the non-bank financial sector. The Bank highlighted DeFi as posing a great risk to investors if the ecosystem continues to operate without proper regulation.
The DeFi Risk
In the BIS Quarterly Review, the institution noted the growth of non-bank financial intermediaries as they offered a wider range of investment opportunities and are a great source for diversity in external financing. Despite their impressive features, they fall short of providing sufficient investor protection and the report beamed a searchlight on the emerging class of DeFi.
“Being a new system of payments and transactions, it promises to overcome some of the disadvantages of traditional finance, such as high costs and slow speed,” BIS said about DeFi. “For now, these gains are difficult to detect: DeFi appears to be operating within its own ecosystem with little in the way of financial intermediation service being provided to the real economy.”
The report suggested that DeFi is prone to several vulnerabilities including “first-order money laundering schemes and other dangers that far exceed those of traditional finance. It suggests that stablecoins that are an integral aspect of DeFi are flawed and price crashes within the ecosystem can spill over to traditional financial systems.
“For instance, stablecoins – the grease between DeFi wheels – are subject to classic runs: the backing of liquid reserve assets can touch downward price spirals akin to those stemming from redemptions in the investment fund industry,” the BIS noted.
DeFi has grown by leaps and bounds in 2021 to reach a market capitalization of 146.05 billion with protocols like Terra and Avalanche leading the charge. “As history confirms, anything that grows exponentially is unlikely to remain self-contained and thus merits the closest attention,” the institution commented as justification for the call for increased regulations.
The Recommendation
The Bank For International Settlements suggests resilient market structures as instrumental in absorbing the spikes in the demand for funding liquidity. The bank highlighted the need for a concerted effort in reducing regulatory gaps.
The BIS noted that “better information” should be prioritized to include enhanced reporting for regulators and enhanced disclosure for the markets. The bank called for regulations to ensure that non-bank financial institutions have sufficient shock-absorbing capacity.
“Other preemptive steps include taking a less fragmented and more consolidated supervisory perspective,” said the BIS. It noted that decentralization is an illusion in DeFi and pivotal entities, including developers, are usually in control.
