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Not only is crypto a financial risk, but stablecoins could cause ‘contagion effects,’ Europe’s central bank writes in a blistering Web3 report

July 11, 2022, 5:09 PM UTC
Christine LaGarde
ECB President Christine LaGarde.
Getty Images

The bear market of 2022 is sending investors into hibernation, and the crypto market is in the deepest part of the cave.

With inflation raging at a 40-year high, recession fears spreading, and an energy crisis wreaking havoc in Europe, stocks and bonds are falling, and risk assets like crypto are on the verge of a collapse.

Since November of last year, the crypto industry has lost more than $2 trillion in value, leaving the overall “crypto market cap” at just $910 billion on Monday. The two leading cryptocurrencies by market cap, Bitcoin and Ether, are now down 57% and 70%, respectively, year-to-date.

This recent drop in crypto prices, along with the downfall of the algorithmic stablecoin TerraUSD, has Europe’s central bank saying enough is enough, or it should be.

In a new report that dissects the growth of the crypto market over the past decade, European Central Bank (ECB) researchers said the industry needs to be regulated in order to prevent “spillover effects” on traditional markets.

“Financial stability risks from crypto-assets are rising and could reach a systemic threshold,” ECB researchers Alexandra Born and Josep M. Vendrell Simón wrote. “Crypto-asset markets thus need to be effectively regulated and supervised.”

This new report comes after the E.U.’s May approval of the Markets in Crypto-Assets (MiCa) regulatory framework that offers guidance on how crypto companies should operate in Europe. MiCa is expected to come into law in 2024, but ECB President Christine Lagarde said last month that more regulation will likely be needed before then.

Lagarde has long been a crypto critic, even going so far as to call cryptocurrencies worthless in a May interview with a Dutch talk show called “College Tour.”

The ECB president has called on regulators to begin work on a proposal for MiCa II, which she says will help to regulate crypto assets in a more “in-depth” way and with a “larger scope” in order to prevent fraud and “criminal dealings.”

Stablecoins and DeFi

The ECB went after stablecoins and DeFi, or decentralized finance, in their latest report as well, with researchers arguing that stablecoins “fall short of what is required of practical means of payment in the real economy.”

“To date, stablecoins’ transaction speed and cost, as well as their redemption terms and conditions, have proven inadequate for use in real economy payments,” they said.

The ECB team added that “holistic and coordinated” regulation is needed to prevent another stablecoin blow-up like TerraUSD. If there is a run-on or failure of one of the larger stablecoins, it could cause “contagion effects” and become “a risk to financial stability,” the researchers said.

The ECB also criticized DeFi for its lack of use cases and the risk it poses to investors in the report.

“To a large extent, it does not create novel financial products, but mimics those provided in traditional financial markets through technology-enabled innovation,” they wrote. “DeFi is in many ways subject to the same vulnerabilities as traditional finance.”  

ECB researchers added that DeFi’s new technologies and decentralized approach can “amplify certain vulnerabilities and incur additional specific risks” as well. 

“DeFi needs to be effectively supervised and regulated,” they concluded.

DeFi ecosystems have lost billions in value over the past few months, as investor fears over another stablecoin mishap continue to hurt sentiment in the space.

There is now roughly $40 billion in “total value locked” on DeFi ecosystems worldwide, according to data from DeFi pulse. That’s down from over $107 billion in November of last year.

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