The European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) have published a joint report analyzing developments in the crypto-asset sector.
The report focuses on decentralized finance (DeFi), crypto lending, borrowing, and staking. This contribution supports the report from the European Commission to the European Parliament and the Council under Article 142 of the Markets in Crypto-Assets Regulation (MiCAR).
DeFi Adoption and Risks Highlighted According to the report, DeFi remains a niche sector, with the total value locked in DeFi protocols representing only 4% of the global market value of cryptoassets. Although the EU’s adoption of DeFi exceeds the global average, it lags behind other advanced economies such as the United States and South Korea.
The report also highlights a correlation between the size of the DeFi market and the number of security breaches. Hacks and thefts in DeFi have increased alongside the growth of the sector, posing significant risks. Additionally, decentralized exchanges account for 10% of global spot cryptocurrency trading volumes, raising concerns about their vulnerability to money laundering and terrorist financing (ML/TF).
The report identifies maximum extractable value (MEV) as a critical issue in DeFi. MEV creates negative externalities across the ecosystem, which the EBA and ESMA believe will require technical solutions to mitigate.
Crypto Lending, Borrowing, and Staking Analysis
The joint report provides an overview of lending, borrowing and staking services in the crypto-asset market. These activities are conducted through both centralized and decentralized platforms, with some crypto-asset service providers (CASPs) in the EU also offering regulated services.
Engagement in crypto lending, borrowing and staking remains limited among EU consumers and financial institutions. The report describes the main risks associated with these activities, including excessive leverage, information asymmetries and exposure to ML/TF risks. Systemic concerns, such as collateral chains, remortgaging and procyclicality, are also highlighted.
The report notes a lack of transparency around fees, interest rates and collateral requirements, leaving some users vulnerable to inadequate disclosures. However, the EBA and ESMA do not currently identify significant risks to financial stability linked to these activities.
Regulatory outlook
Under Article 142 of MiCAR, the European Commission is responsible for assessing the development of DeFi and the regulatory needs of decentralized systems and lending and borrowing of crypto-assets. The contribution from EBA and ESMA provides detailed information to inform these assessments.
The report highlights the need for a balanced regulatory approach to address emerging risks while fostering innovation in the sector. The EBA and ESMA will continue to monitor developments in crypto-assets as part of their broader mandate to supervise innovative activities in the EU banking, payments and securities sectors.
By highlighting these critical issues, the report aims to support EU efforts to develop a comprehensive regulatory framework for cryptoassets and DeFi.
