By Huw Jones
LONDON (Reuters) - Decentralised finance catering for cryptoassets could undermine financial stability if it gained traction and more safeguards are needed, the Bank for International Settlements said in its quarterly review on Monday.
So-called DeFi platforms allow users to lend, borrow and save, usually in cryptoassets and stablecoins, while bypassing traditional, centralised gatekeepers of finance such as banks.
DeFi has the potential to complement traditional financial activities, but it currently has few real-economy uses and, for the most part, supports speculation and arbitrage across multiple cryptoassets, the BIS said in its quarterly review.
The limited application of anti-money laundering rules and customer checks, along with transaction anonymity, exposes DeFi to illegal activities and market manipulation, the Swiss-based global forum for central banks said.
DeFi's main premise of reducing costs by removing intermediaries seems yet to be realised, the BIS addded.
"There is a 'decentralisation illusion' in DeFi since the need for governance makes some level of centralisation inevitable and structural aspects of the system lead to a concentration of power," the BIS said.
"If DeFi were to become widespread, its vulnerabilities might undermine financial stability."
Major investors have bet heavily on the growth of the sector, with Canadian pension fund Caisse de Dépôt et Placement du Québec in October taking part in a $400 million investment in major lending platform Celsius Network.
(Graphic: DeFi BIS Graphic 1, https://fingfx.thomsonreuters.com/gfx/mkt/jnpweaewdpw/DeFi%20BIS%20Graphic%201.PNG)
If risks from DeFi are not well managed, stablecoins are prone to runs and possible fire sales of the assets backing them could generate funding shocks for companies and banks, feeding through to the wider financial system, the BIS said.
"Since the main challenges in DeFi resemble those in traditional finance, established regulatory principles can serve as a compass," it said.
(Graphic: DeFi BIS Graphic 2, https://fingfx.thomsonreuters.com/gfx/mkt/zgvomnmrgvd/DeFI%20BIS%20Graphic%202.PNG)