ESMA Highlights DeFi’s ‘Serious Risks’ And Benefits

On a Wednesday report, the European Securities and Markets Authority released a statement on Decentralized Finance (DeFi) covering its ‘serious risks’ for the EU market despite its innovative technology being in its infancy.

The report titled “Decentralized Finance in the EU: Development and Risks” highlights the DeFi risks and benefits posed by a sector that holds much promise and reshaped finance in the European region.

According to the report, DeFi has led to the innovation of financial products making payments easier and aiding financial inclusion to cater to the unbanked around the world. While DeFi has its benefits, it also has its risks. As per the report, the first liquidity risk is tied to the highly speculative and volatile nature of many crypto assets. ESMA compared the 30-day volatility of Bitcoin and Ether with the Euro Stoxx 50 index with the crypto just being on average about 3.6 and 4.7 times higher than the stock index. 

In this case, ESMA doesn’t believe that DeFi manages to avoid counterparty risk even if it should be lower or even non-existent due to smart contracts and atomicity. However, smart contracts do not have immunity to errors or flaws. ESMA also added that DeFi is very vulnerable to scams as it lacks know-your-customer (KYC) protocols and lacks an identifiable responsible party and the absence of a recourse mechanism.

At this stage, ESMA continues to keep an eye on the crypto market after the release of its second consultative paper in the MiCA regulations last October 5. The regulation suggested allowing crypto asset providers to store transaction data in “the format they consider most appropriate,” if they can turn it into a specified format in case the authorities require it.