The independent financial market regulator of the European Union recognized the innovativeness of cryptocurrencies, but emphasized its instability, which carries risks for all existing asset classes.
The European Securities and Markets Authority published its Financial Innovation Report 2021 Trends, Risks and Vulnerabilities. The document notes that cryptocurrency is an innovative technology, but its costs, both financial and environmental, require careful attention of financial regulators.
“Most cryptoassets (CAs) are highly volatile in price and operate outside of the existing EU regulatory framework, which raisesinvestor protection issues.”
As noted in the ESMA report, COVID-19 contributed to the digitalization and development of the digital technologies, and this, in turn, led to an increase in the efficiency of services that provide financial services. The downside of this process is the emergence of new challenges, including security and data management risks.
“Following a boom in 1Q21, the market capitalisation of crypto assets fell by almost 40 % in May, once again highlighting their high price volatility of those instruments. Meanwhile, Decentralised Finance continues to gain momentum. Finally, regulators’ engagement with FinTech through innovation hubs and regulatory sandboxes is becoming mainstream across the EU, with benefits for both parties.”
ESMA says the volatility of cryptoassets, along with the rise in decentralized finance (DeFi), central bank digital currencies (CBDCs) and stablecoins, is contributing to increased risk across all asset classes.
“The potential introduction of Central Bank Digital Currencies (CBDCs) and the increasing use of stablecoins as well as the increased interest on CAs by institutional investors is making more porous the boundaries between the traditional CeFi system and DeFi more porous, increasing the risks of potential spillover of DeFi risks to the real economy.”