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Europe: ESMA Warns of Growing Links Between Crypto and Financial Markets
11h05 ▪5min read ▪ byEvans S.
Getting informed▪Crypto regulationSummarize this article with:
The links between crypto and traditional finance are becoming significant enough to attract more attention from the European regulator. In its risk monitoring report published on September 10, ESMA calls for close monitoring of this interconnection. Tokenized stocks, DeFi and prediction markets are directly cited. The regulator does not yet speak of an established systemic risk, but rather new channels capable of transmitting a crypto shock to the rest of the financial markets.
In brief
- ESMA monitors the convergence between the crypto market and traditional finance.
- Tokenized stocks and DeFi exploits are among the identified risks.
- Prediction markets also pose manipulation and insider trading issues.
Crypto and traditional finance are becoming less and less separated
The phrase used by ESMA is quite clear. The regulator calls for increased monitoring of the growing link between crypto markets it considers “increasingly vulnerable” and the financial system at large.
Tokenized stocks are one of the examples cited. Their weight is still negligible compared to global equity markets. Nevertheless, their adoption is progressing, bringing new infrastructures, new investors and new intermediaries into the same circuit.
We had already detailed ESMA’s reservations regarding tokenized stocks, especially when the token does not grant exactly the same rights as the traditional stock it represents.
The change in tone is interesting. In March, ESMA still wrote that adoption of tokenization remained limited, with relatively low volumes and narrow applications. It already acknowledged progress and possible advantages: faster settlement, automation by smart contracts or using traditional assets in DeFi.
Six months later, adoption remains early. But the topic now also appears in the category of financial transmission risks. The boundary is shifting.
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DeFi exploits can now go beyond crypto alone
DeFi forms the second point. ESMA mentions recent protocol exploits as a renewedeffects. It does not provide, in its statement, a precise list of the incidents responsible for this concern
The mechanism is quite simple. As long as a DeFi protocol only handles purely crypto assets, a loss remains mostly concentrated in that ecosystem. Things change when the same protocols host tokenized stocks, money market funds, private credit or other assets from traditional finance.
A compromised smart contract can then affect assets whose value and counterparties are outside the blockchain.
This is precisely the convergence that ESMA is monitoring. The issue goes beyond Europe. The OECD identified this year the growth of connections between crypto and traditional markets as a potential contagion risk, especially
This does not mean that a DeFi attack would cause a European financial crisis today. ESMA does not claim this. It rather says that the more the two systems use the same assets and actors, the harder it becomes to consider their risks separately.
Tokenization is precisely accelerating this convergence. Cointribune recently noted that tokenization is becoming a major project for financial institutions.
Prediction markets add another problem
The third issue is less related to credit or liquidity risk. It concerns market integrity. According to ESMA, prediction markets may present increased risks of insider trading, wash trading and coordinated manipulation. The use of crypto infrastructures may also complicate detection of some of these practices.
The regulator had already begun to focus on this before the new report. In July, it reminded that some contracts based on a binary outcome might fall under existing European rules on binary options. It all depends on the product and the underlying event. Some contracts may also fall under national gambling laws.
We then explainedhow ESMA regulates prediction markets in Europe. The sector has nonetheless continued to grow. Platforms now allow positions on elections, economic decisions, sports events or legislative texts. For ESMA, the problem is therefore no longer just whether a token falls under MiCA or a DeFi protocol operates without intermediaries. Crypto is starting to share more assets, liquidity and users with traditional finance. For now, ESMA talks about monitoring and vulnerabilities, not an ongoing crisis.
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Evans S.
Fascinated by Bitcoin since 2017, Evariste has continuously researched the subject. While his initial interest was in trading, he now actively seeks to understand all advances centered on cryptocurrencies. As an editor, he strives to consistently deliver high-quality work that reflects the state of the sector as a whole.
The views, thoughts, and opinions expressed in this article belong solely to the author, and should not be taken as investment advice. Do your own research before taking any investment decisions.
Source: www.cointribune.com