On 25 May 2023, the European Systemic Risk Board (ESRB) published a report, focussing on the systemic implications of crypto-asset markets and proposing policy options to mitigate the risks associated with crypto-assets and decentralised finance (DeFi) for the stability of the EU financial sector. Importantly, the report also takes into account the potential impact of the new EU Regulation 2023/1114 on Markets in Crypto Assets (aka MiCA).

According to the report, although the past year has been marked by volatility in the crypto and DeFi sectors, their impact on the overall financial system has been limited. Currently, the crypto market has minimal connections with the traditional financial sector and the real economy, and these connections are not significant.

However, due to the exponential growth and high volatility of cryptocurrencies, close monitoring is necessary as they have the potential to pose systemic risks. In turn, systemic risks could arise quickly and suddenly posing a risk to financial stability. These risks could emerge if the interconnections between the crypto market and traditional finance increase over time, if new connections go unnoticed, or if similar innovations like distributed ledger technology gain widespread adoption in traditional finance.

In order to gain a better understanding of the developments in crypto-assets and their implications for financial stability, the report identifies three policy priorities, which are ranked by urgency and significance.

Firstly, it emphasises the need to strengthen the EU's capacity to monitor potential contagion channels. This includes monitoring links between the crypto sector and traditional finance, as well as internal connections within the crypto sector. To achieve this, standardised reporting and disclosure requirements should be promoted for banks and financial institutions with exposure to cryptocurrencies, investment funds with crypto holdings, and entities such as stablecoin issuers or e-wallet service providers in the crypto sector.

Secondly, the report discusses policy options to address two potential risk transmission channels within the crypto-asset sector, namely, risks stemming from crypto conglomerates, leverage using crypto-assets.

Thirdly, it highlights the need to monitor market developments such as potential risks in relation to operational resilience, DeFi, and crypto staking and lending to safeguard that potential risks to financial stability and the effectiveness of macro prudential policy can be identified, assessed, and mitigated.

These policy options can serve as valuable insights for future regulatory initiatives, ensuring the effective management of risks associated with crypto-assets and DeFi.

The press release can be found here and the report can be accessed here.