The European Central Bank released a new report on the crypto industry mentioning the risks related to stablecoins, DeFi, and climate impact.
Related: European Union's New Rules Say Crypto Transfers Should Be Traced
According to the ECB, the rise of crypto presents risks to financial stability and may reach a systemic threshold. To prevent the associated consequences, the market needs to be effectively regulated and supervised, the institution finds.
Stablecoins and their role within the broader digital assets industry and beyond were the main focus of the report. Writing about the role of these assets, the ECB researchers said they were created to address high price volatilities in crypto. However, the crash of the popular stablecoin ecosystem Terra in early May shows that stablecoins may lose their peg and collapse.
The ECB warns that the fast growth of stablecoins and their use cases hold a potential financial risk of contagion effects at some point. Stablecoins have an essential role in the crypto market liquidity, which means that they can have wide-ranging implications in case of failure. In its turn that could have contagion effects for the financial system. The ECB mentioned that currently, when the crypto market is under stress, the largest stablecoin Tether faced large outflows with its market cap dropping by 10%, and that led to redeeming by liquidation of reserve assets.
The bank says stablecoins need to be brought into the regulatory perimeter urgently. It also stressed the need for DeFi regulations, saying the sector generally mimics TradFi products through tech-enabled innovation. The ECB says DeFi has vulnerabilities and risks so it should be regulated.