Today the European Systemic Risk Board (ESRB) published a paper outlining potential policy options for crypto-assets and decentralized finance (DeFi). Like other stability boards, it focuses on how to prevent any instability in the crypto sector from impacting traditional finance (TradFi). The paper also suggests how future regulations might apply to DeFi.
Current minimal banking crypto exposure
At the moment, the ESRB sees limited interconnectedness between crypto and TradFi, although it is concerned that it could change quickly. It shared some stats from a survey of 105 Europan banks in mid-2022.
Just three banks had any banking or trading book exposures, and the figure was less than €100,000 combined. One bank had a crypto derivative exposure of around €100 million. Two banks had crypto assets under management totaling €5 million. And three banks held crypto in custody with a combined value of €212 million.
Another survey of fund managers found that 111 funds had crypto-asset exposure out of 60,000 EU-domiciled funds. The funds were generally small, with one exception where the crypto exposure was less than 10% of assets under management.
Stablecoins are a significant concern, and the paper ponders what might happen if the notorious Tether stablecoin – the largest one – became systemic. It measures systemic as equalling the size of BlackRock’s total money market funds (currently around $480 million). While it mentions that it would require growth of ten or 20 times from today’s Tether value, the figure is closer to six times.
DeFi policy proposals
With the EU’s MiCA legislation for crypto-assets now approved and about to come into force, the question has turned to the next iteration, which will likely cover DeFi, although it’s a few years off.
The paper had some specific policy recommendations. The legislation will likely require DeFi smart contracts to have some kind of audit and testing. It also mentioned design requirements, but that would have to be pretty high level.
Legislation could limit how DeFi smart contract code might be licensed. This point was a little unclear, but perhaps the aim is for the license owner – the developer – to take on some responsibilities or liability. However, the paper explicitly made a separate point that there might be tort liability on the developer to incentivize them to have the code audited.
Other EU legislation around data recently proposed a kill switch on smart contracts that could be used to correct faulty code, and that was also suggested in this ESRB paper. Additionally, it proposes regulating the degree of leverage allowed.
The final suggestion was a vague reference to stipulating requirements for oracles that interact with DeFi smart contracts.
While those are the DeFi suggestions, there were three high level proposals. These were to:
- monitor contagion channels between TradFi and crypto
- asses risks from crypto-conglomerates and crypto leverage
- promote EU knowledge exchange, especially re DeFi and crypto staking and lending.