The Bank for International Settlements-BIS concluded the decentralized finance space could play an important role in the traditional financial system but warned about the potential financial instability according to the reports that we are reading more about in our latest cryptocurrency news.
According to the report, Defi risks and the decentralization illusion, DeFi could with regulatory improvements become a more integrated part of the broader financial system than it is today:
“History shows that the early development of novel technologies often comes with bubbles and loss of market integrity, even while generating innovations that could potentially be of broader use down the road.”
However, it added that if blockchains were to improve scalability and there’s large-scale tokenization of traditional assets and with suitable regulation is introduced to the market, DeFi could play a huge role in the financail system. BIS concluded that the Defi’s potential relevance it said that its growth poses financial stability concerns:
“Since collateral prices fall and margins rise at times of distress, downward price spirals often arise and may spread to the rest of the financial system.”
It added that the reason for this hasn’t yet happened is that the DeFi space is largely self-contained. The report also pointed to stablecoin as an area of particular concern saying that these are not commercial bank money nor central bank money. The report argued that stablecoins are prone to runs that will compromise the ability to transfer funds in the Defi system which could cause some funding shocks for both companies and banks with the potential for a severe impact on the financial system and economy. To control these risks, the BIS suggested that the regulatory framework exists in traditional finance if it is applied to the DeFi space for both companies and banks with the potential for a huge impact on the financial system and the economy.
To better control the risks, the BIS suggested that the regulatory framework exists in the traditional finance if it is applied to the DeFi space and that tools are used to regulate and supervise the banks that could be expanded to cover stablecoin issuers. The report also focused on what is called the illusory decentralization in Defi because protocols have an inescapable need for centralized governance when it comes to making strategic decisions. The BIS report argued:
“Public authorities would need to interface with DeFi’s inherent governance structures, so as to ensure sufficient financial stability safeguards as well as to enhance trust by addressing investor protection issues and illegal activities.”
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