Bank for International Settlements Issues DeFi Warning, Says Potential for Disaster Not To Be Underestimated

The Bank for International Settlements (BIS) is saying that decentralized finance (DeFi) is a cause of concern to the financial system.

The international financial organization supporting central banks globally to achieve monetary and financial stability says that DeFi inadequately protects investors and is susceptible to money laundering.

According to the Bank for International Settlements, DeFi is prone to “substantial financial vulnerabilities.” BIS says that concerns over solvency could impact fiat-pegged crypto assets like stablecoins, a situation that could lead to massive simultaneous withdrawals and ultimately default.

“At the same time, besides giving rise to first-order money laundering and investor protection concerns, DeFi displays substantial financial vulnerabilities. These parallel but exceed those in more traditional forms of finance.

For instance, stablecoins – the grease between DeFi wheels – are subject to classic runs: the backing of liquid claims with less liquid reserve assets can touch off downward price spirals akin to those stemming from redemptions in the investment fund industry.”

The Bank for International Settlements says that while it is unclear whether the risks in the crypto ecosystem could spread to traditional finance, the possibility should not be “underestimated.”

“In the crypto ecosystem, risks have so far surfaced mainly infrequent and sizeable price crashes. Whether such fragilities are limited to this ecosystem or can spill over to the traditional one is still unclear.

But the potential for spillovers should not be underestimated, especially since the stablecoin arrangements themselves can create important links. As history confirms, anything that grows exponentially is unlikely to remain self-contained and thus merits the closest attention.”

The Bank for International Settlement also says that the benefits of DeFi to the “real economy” are “difficult to detect.”

“Being a new system of payments and transactions, it [DeFi] promises to overcome some of the disadvantages of traditional finance, such as high costs and slow speed.

For now, these gains are difficult to detect: DeFi appears to be operating largely within its own ecosystem, with little in the way of financial intermediation services being provided to the real economy.”

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