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The Financial Stability Risks of Decentralised Finance

The Financial Stability Board (FSB) published a report on the financial stability risks of Decentralised Finance (DeFi). DeFi is commonly used to describe services in crypto-asset markets that aim to replicate some functions of the traditional financial system in a supposedly decentralised manner – though the actual level of decentralisation varies widely.

The report, which was delivered to the February G20 Finance Ministers and Central Bank Governors meeting, concludes that while the processes to provide services are in many cases novel, DeFi does not differ substantially from traditional finance in the functions it performs or the vulnerabilities to which it is exposed. DeFi’s specific features may result in some of these vulnerabilities – such as operational fragilities, liquidity and maturity mismatches, leverage and interconnectedness – playing out at times differently than in traditional finance.

The extent to which these vulnerabilities can lead to financial stability concerns largely depends on the interlinkages and transmission channels between DeFi, traditional finance and the real economy. To date, these interlinkages are limited. However, if the DeFi ecosystem were to grow significantly, then the scope for spillovers would increase. The report identifies indicators that can be used to monitor DeFi vulnerabilities and transmission channels.

Categories: Recommended Readings
Author: FSB