Financial regulatory body examines potential instability of Decentralized Finance (DeFi) and cryptocurrencies as they approach a significant growth milestone, known as "critical mass".

The Bank for International Settlements (BIS) has released a paper exploring the financial stability risks associated with cryptocurrencies and decentralised finance (DeFi). The paper emphasises the fragile nature of stablecoins, the systemic risks arising from DeFi’s interconnected protocols, and the challenges posed by limited regulatory oversight.

Key points on financial stability risks include:

Stablecoins' fragility and systemic risk: Many stablecoins show significant deviations from their pegs, exposing them to runs and instability that could spill over to traditional finance, especially as stablecoins become increasingly integrated in payment systems and banking sectors.
Interconnectedness and systemic contagion: DeFi protocols are highly interconnected with each other and increasingly with traditional finance through stablecoins and crypto asset adoption. This interconnectedness raises the risk of cascading failures without central authorities to intervene, increasing systemic fragility compared to traditional finance.
Regulatory gaps and market vulnerabilities: DeFi’s decentralised nature limits oversight, increasing vulnerability to fraud, poor security, and high transaction costs, as highlighted by recent crypto platform failures. The lack of standardised anti-money laundering (AML) compliance also poses risks.
Capital requirements and fragmentation: The BIS has raised concerns about inconsistent capital rules for banks dealing with crypto, which may create regulatory fragmentation and discourage integration, potentially undermining systemic stability by limiting transparency and oversight in crypto finance.

In terms of policy approaches suggested by the BIS:

Stronger regulatory frameworks: Implement frameworks for stablecoins and crypto assets to address transparency, capital adequacy, and operational risks akin to TradFi standards, reducing regulatory arbitrage and fragmentation.
Supervisory oversight and risk management: Enhance oversight of DeFi protocols and marketplaces, including risk monitoring of interconnected exposures, to prevent unchecked systemic risks from cascading failures.
AML compliance in DeFi: Develop targeted policies, technical solutions, and community-driven standards to improve anti-money laundering compliance in DeFi without compromising its decentralisation ethos.
Promotion of CBDCs: The BIS advocates for central bank digital currencies as safer monetary instruments that can provide stability and compete with fragile stablecoins, while supporting monetary sovereignty.

The paper suggests that the policy approaches to crypto could take three forms: ban, contain or regulate, implying a ban would be a bad idea. The International Monetary Fund (IMF) has been highlighting the topic of cryptoisation risks for emerging market economies for some time. Another central banker has observed that bitcoin can be a means for redistributing wealth from late investors to earlier ones, who tend to be wealthy.

The paper concludes that the crypto market has "reached critical mass" and is no longer self-contained. Traditional finance (TradFi) asset managers and broker dealers are becoming more involved in the crypto market, and decentralised exchanges (DEXs) could start to be used more widely by TradFi firms and become part of the mainstream. Beyond crypto, the paper expresses concern about TradFi using DeFi smart contracts within TradFi.

The authors consider research into the financial stability implications of real world asset (RWA) tokenization as a top priority, as RWA expansion is potentially including more mainstream assets in DeFi. The authors also want to explore how to address the cryptoisation risks for emerging market economies and the potential instability of stablecoins. To safeguard the interest of market participants in DeFi, the authors propose imposing similar requirements to TradFi on DeFi, including know your customer compliance, disclosures, and adequate training and qualifications for market professionals.

[1] Bank for International Settlements (BIS), "Financial stability implications of decentralized finance (DeFi)", January 2023. [2] Bank for International Settlements (BIS), "Central bank digital currencies: foundations, challenges and prospects", June 2025. [3] European Union, "Markets in Crypto-Assets (MiCA)", proposed regulation, 2022. [4] United States, GENIUS Act, proposed legislation, 2023.

Financial regulatory body examines potential instability of Decentralized Finance (DeFi) and cryptocurrencies as they approach a significant growth milestone, known as "critical mass".