Decentralized finance (DeFi) is expected to increase in prominence, finding traction in use cases such as lending, trading, and investing, without the intermediation of traditional financial institutions. According to GlobeNewswire, estimates from a market research firm peg the global decentralized finance market at ~USD 14 billion in 2022 and the market is expected to reach ~USD 446 billion by 2030, at a CAGR of ~46.0%. Accordingly, the financial services market participants and regulators alike are increasingly focusing on DeFI. Regulators are monitoring developments in this area and looking to better understand the interconnectedness or systemic risk implications of the increasing use of this technology.
In the first quarter of 2023, a report from the Financial Stability Board (FSB) examined the financial stability implications of DeFi. The analysis concluded that, FSB and other standard-setting bodies, will explore approaches to measure and monitor the interconnectedness of DeFi with traditional finance (TradFi). As the use cases and regulatory approaches around DeFi are still evolving, FSB will explore the extent to which its proposed policy recommendations for the international regulation of crypto-asset activities may need to be enhanced to take account of DeFi-specific risks and facilitate the enforcement of rules. In the recent past, the Bank for International Settlements (BIS) has published papers investigating challenges stemming from DeFi lending and DeFi oracles, which are third-party services that allow smart contracts to access real-world data. Additionally, Project Atlas, led by the BIS Innovation Hub, aims to build an open source data platform to provide information on market capitalization, economic activity, and international flows of crypto-assets.
Another recent development is issuance of the proposed policy recommendations from the International Organization of Securities Commissions (IOSCO) on how to regulate crypto-assets, with the aim to establish a global approach to address risks in DeFi. This IOSCO publication also discusses the growth of DeFi and the impact of recent market developments on DeFi investors and markets. It highlights that, in 2023, the failure of a US regional bank that offered deposit services to a stablecoin issuer contributed to a temporary de-pegging of the stablecoin because of uncertainty about the issuer’s access to its deposits. The proposed policy recommendations, which are principles-based and outcomes-focused, target decentralized finance products, services, arrangements, and activities. The recommendations are aimed at:
- Understanding decentralized finance arrangements and structures
- Assessing interconnections among the DeFi market, the broader crypto-asset market, and traditional financial markets
- Achieving common standards of regulatory outcomes
- Identifying and managing key risks, including the operational and technology risks
- Ensuring clear, accurate, and comprehensive disclosures
- Enforcing applicable laws
- Promoting cross-border cooperation
The consultation period on the IOSCO policy recommendations ends on October 19, 2023. IOSCO aims to finalize the proposed recommendations by the end of 2023, in accordance with its Crypto-Asset Roadmap of July 2022.
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