While decentralised financial technologies do pose risks, they may increase competition and diversity in the financial system and reduce existing entities’ systemic importance.
The FSB (Financial Stability Board) has released a report setting out the financial stability, regulatory and governance implications of using decentralised financial technologies.
The report focuses on technologies that may reduce or eliminate the need for intermediaries or centralised processes that have traditionally been involved in the provision of financial services.
While applications that decentralise financial services have yet to achieve economically significant scale, they may over time have a noticeable economic impact, the report says, noting specific applications in payments and settlement, capital markets, trade finance and lending.
The report makes a preliminary assessment of the implications of decentralised financial technologies for financial stability, and some issues they might raise in relation to financial supervision and regulation.
The report says the application of decentralised financial technologies could reduce some of the financial stability risks associated with traditional financial institutions and intermediaries. For example, a more decentralised financial system may lead to greater competition and diversity in the financial system and reduce the concentration of service providers.
“Some decentralised technologies could reduce the reliance on existing intermediaries to channel short-term funding into lending, thereby reducing solvency and liquidity risks arising across their balance sheets,” it adds, alluding to reduced systemic importance of some existing entities.
At the same time, the use of decentralised technologies may also raise risks to financial stability. This may include new forms of concentration risks, such as those related to who owns the assets, controls the source code, or operates the infrastructure in a decentralised system.
Greater procyclicality could also emerge, particularly in the supply of credit, the report says. “For example, P2P matching platforms may exhibit larger and sharper swings in their provision of credit than existing financial institutions,” particularly in cases where lending decisions are automated or rely on novel data or untested models.
New uncertainties concerning the determination of legal liability and consumer protection may also affect public trust in the financial system, and recovery and resolution of decentralised structures may also be more difficult.
In the event of a threat to financial stability, decentralised financial services might also be less responsive to official sector interventions such as liquidity facilities or other services provided by central banks.
In addition, significant use of decentralised financial technologies may have implications for the effectiveness and enforceability of current regulatory frameworks, particularly those that currently focus on centralised financial institutions.
A more decentralised financial system may reinforce the importance of an activity-based approach to regulation, particularly where it delivers financial services that are difficult to link to specific entities and/or jurisdictions.
The report considers issues related to the governance of technological development, and the activities of businesses and users of technology, which it says could have implications for financial regulation and financial stability.
These issues include the use of decentralised systems to circumvent regulation and facilitate misconduct, the difficulty of regulatory enforcement in the event of misconduct, and the increased jurisdictional uncertainty.
To help avoid the emergence of unforeseen complications in the design of decentralised financial technologies at a later stage, regulators can consider engaging in further dialogue with a wider group of stakeholders with whom interaction has been limited to date, such as those in the technology sector.
The report, available here, has been delivered to G20 Finance Ministers and Central Bank Governors for their meeting in Fukuoka on 8-9 June, which includes a High-Level Seminar on Financial Innovation.