The European Union's financial stability watchdog has stated that new laws may be required to safeguard massive crypto conglomerates and smart contracts, as it cautions that a burgeoning digital asset and decentralized finance (DeFi) industry may represent a systemic risk to the economy.
The European Systemic Risk Board (ESRB), chaired by EU central bank chief Christine Lagarde, warned in a Thursday report of the risks of crypto lending and staking, as well as high leverage in digital asset markets, with the new Markets in Crypto Assets regulation (MiCA) set to take effect within the bloc in 2024.
“DeFi developers could be required to abide by specific regulations covering the design and creation of smart contracts,” according to one policy option, according to the research. It suggests mandated code audits, pharmaceutical-style intellectual property constraints, and guidelines for “oracles” that send real-world data to automated software.
While MiCA establishes governance, licensing, and reserve requirements for players such as wallet providers and stablecoin issuers, it excludes areas such as crypto lending and staking, despite the research warns that these areas potentially pose “significant risks to consumers.”
Companies will have to handle conflicts of interest between their business lines under MiCA, but there is no overall duty to identify and mitigate the operational or reputational risks that may arise from providing services such as trading and custody, according to the ESRB.
“Taking into account any market developments and experience gained with the application of MiCA,” the paper added, citing existing payment legislation that allow supervisors to require hazardous services to divest to a separate business.
“While this past year has been turbulent for crypto-assets and DeFi, systemic implications have not materialized,” the paper stated, adding that “exponential growth dynamics” could mean future disruptions pose a huge threat similar to Lehman Brothers' 2008 collapse.
The ESRB recommended in March that financial technology businesses should face bank-style lending limitations to prevent crypto markets from overheating, citing the increased popularity of cryptocurrency.