This article briefly:
The Bank of Italy report argues that digital currencies and decentralized finance have failed to deliver on their grandiose promises.
The report highlights the limited real-world adoption of DeFi, despite its potential benefits to the financial system.
Regulators need to address the “decentralization fantasy” and develop appropriate regulations for crypto assets and DeFi.
Cryptocurrencies, DeFi, and stablecoins, in particular, promised to change the global financial system for the better. But according to a new report from the Bank of Italy, they have failed to deliver on that promise. The paper explores the regulatory challenges facing crypto asset markets amid severe market turmoil in 2022. Its assessment is bleak, but there is still room for optimism.
The 34-page report concludes that cryptocurrencies and blockchain “have yet to deliver on many of their promises regarding efficiency, resilience, and transparency in the financial system.” Still, it does note that “effective regulation” could help realize those benefits, including making the financial system more efficient and competitive.
Bank of Italy: Stablecoins are not stable at all
The report acknowledges that DeFi offers many benefits, including smart contract automation, atomic settlement, and transparency, which enable rapid value transfers with reduced execution risk and fewer intermediaries. However, despite its huge potential, the report finds that actual applications have been limited to date.
The central bank also recognises the broad potential of blockchain, or DLT, to transform and make the financial system more efficient. But it is careful to distinguish them from cryptocurrencies, which the Bank of Italy says have evolved into more speculative assets since the creation of Bitcoin after the 2008 financial crisis.
The report continues:
“In fact, stablecoins, which are sometimes described as valid alternatives in the cross-border payment market, have not proven to be stable. The rise and fall of many crypto assets, regardless of their specific nature and underlying economic function, are mainly driven by waves of speculation. Market manipulation and insider trading are common, and the rights of holders are far from certain, as are the tools to enforce those rights.”
It warned regulators not to ignore the notorious and dangerous boom and bust cycles of crypto assets. It warned that the blurring between traditional finance and cryptocurrencies poses risks to financial stability.
Regulators must confront the “decentralization fantasy”
The report argues that the “decentralization fantasy” of DeFi and cryptocurrencies needs to be debunked. It notes that most protocols have core stakeholders “capable of directing operations and potentially extracting ownership interests.”
The report notes the potential for decentralized autonomous organizations (DAOs) to balance this issue, but says there should be legal frameworks to better accommodate them.
Furthermore, the report acknowledges that regulators and policymakers face difficult decisions. Namely, whether to adopt regulations specifically targeting crypto assets and related services that do not fit into any existing categories.
DeFi “seems inconsistent with the traditional financial services regulatory system” and presents a particular challenge. The choices here are critical, and there is no “one size fits all” option.
The dilemma mirrors what is happening in the U.S. and other jurisdictions, where the Securities and Exchange Commission is trying to apply existing securities laws to crypto assets, and calls are growing for rules for the technology.