Europe and DeFi: ESMA's Assessment

It’s a fact: decentralized finance (or DeFi) and crypto are well and truly present on the European market. In a detailed report, the European Securities and Markets Authority (ESMA) takes a close look at this new financial era. Read on for more details!

The decentralized finance ecosystem is currently too small to pose a real threat to financial stability, according to the European Securities and Markets Authority (ESMA). https://t.co/mm9xL08FRi

— Cointelegraph (@Cointelegraph) October 12, 2023

“DeFi and crypto do not constitute a risk to financial stability”, according to ESMA

In a report published on October 11, ESMA assesses the developments as well as the risks associated with DeFi and crypto within the European Union. According to the regulator, DeFi and crypto do not yet pose a “significant risk” to overall financial stability.

ESMA’s conclusion on DeFi and crypto is based on several key factors. Firstly, the size of DeFi is relatively modest compared to traditional financial institutions in the EU.

• The total market for crypto assets (including DeFi) is just over $1 trillion.
• The total value locked (TVL) in DeFi, meanwhile, amounts to just $40 billion.
• By comparison, the total assets of financial institutions in the EU amounted to around $90 trillion in 2021 (according to the European Commission).

ESMA’s studies also looked at several crypto contagion events in 2022. These include the collapse of the Terra ecosystem and FTX. According to the regulator, these crypto events had little significant impact on traditional financial markets.

What are the risks and benefits for the EU?

The ESMA report highlights several benefits of DeFi and crypto. These include:

• increased financial inclusion,
• the development of innovative financial products,
• a clear improvement in the speed, security and cost of financial transactions.

ESMA nevertheless maintains that the risks of DeFi and crypto are not negligible. According to the organization, liquidity is the main risk. Because of the volatility of crypto assets, DeFi is subject to rapid and unpredictable price fluctuations.

ESMA thus compares the 30-day volatility of the crypto currencies Bitcoin and Ethereum to the Euro Stoxx 50 index. The former is on average 3.6 to 4.7 times higher than the latter.

Another risk to consider is DeFi’s vulnerability to scams and illicit activity. This is mainly due to the absence of identity verification or KYC protocols.

Although vigilant, ESMA therefore considers that DeFi and crypto do not threaten the EU’s financial stability. At least for the time being!