The rapid growth of the cryptocurrency market has brought about new and innovative financial instruments such as smart contracts, high-leverage trading, and crypto staking and lending. While these advancements have the potential to revolutionize the financial industry, they also pose significant risks that cannot be ignored. Recognizing the need to safeguard the stability of the financial system, the European Systemic Risk Board (ESRB) has highlighted the necessity for new regulations to mitigate the risks associated with these emerging practices.
EU Financial Watchdog Calls for New Laws to Address Systemic Risks
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 an expanding digital asset and decentralized finance (DeFi) industry may represent a systemic risk to the economy.The European Systemic Risk Board (ESRB), presided over by Christine Lagarde, head of the European Central Bank, issued a report on Thursday warning of the dangers of crypto lending and staking as well as of high leverage in digital asset markets, with the new Markets in Crypto Assets regulation (MiCA) scheduled to go into effect within the bloc in 2024.
Proposed Policy Measures to Enhance Security and Reliability
The report suggests a policy option that would entail imposing specific regulations on DeFi developers regarding the design and creation of smart contracts. This is aimed at ensuring the security and reliability of smart contracts, which can be vulnerable to coding errors or weaknesses. As part of this policy, mandatory code audits could be required to identify and address any flaws or vulnerabilities in the code. In addition, the report discusses the possibility of implementing pharmaceutical-style intellectual property restrictions for DeFi developers. Furthermore, the report suggests the need for rules and regulations for “oracles,” which are responsible for transmitting real-world data to automated software within the DeFi ecosystem.
New Regulations to Address MiCA’s Shortcomings
While the forthcoming Markets in Crypto Assets regulation (MiCA) addresses governance, licensing, and reserve requirements for certain entities like wallet providers and stablecoin issuers, it does not specifically cover areas such as crypto lending and staking. However, the report highlights that crypto lending and staking pose significant risks to consumers. The absence of regulations in these areas may expose consumers to potential scams, insolvencies, or inadequate risk management practices.According to the ESRB, there is no overarching duty to identify and mitigate the operational or reputational risks that could accumulate from providing services like trading and custody. Companies will be required to handle conflicts of interest between their business lines under MiCA.
Call for In-depth Analysis In Rapidly Growing Industry
The report suggests studying the activities of crypto-asset conglomerates in the EU, considering market developments and the experience with MiCA. Existing payment laws could be used to separate risky services into separate subsidiaries. Although there haven’t been systemic implications so far, the report warns that the rapid growth of the industry could lead to future disruptions similar to the 2008 collapse of Lehman Brothers.