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European Finance Regulator Refers to Cryptocurrencies as “Trending Financial Innovation”

The financial Trends and Risks report was issued last week by The European Securities and Markets Authority, and crypto took up a fair amount of the deliberations.

The financial innovation list was led by crypto assets and distributed ledger technology (DLT) per the published report by the European Securities and Markets Authority’s (ESMA) 2021 last week. 

A multitude of considerations was assessed in the “Trends, Risks, and Vulnerabilities” hefty report. Although crypto is clearly and undeniably marked as incredibly innovative and trendy financial development, the sustainable finance element is yet missing due to mining-related environmental threats and concerns. 

Consequentially, rising risk across all asset classes is attributed to the volatility of crypto assets, stablecoins, decentralized finance (DeFI), as well as central bank digital currencies (CBDCs). 

According to the report, apart from the high volatility of crypto assets, investor protection issues are raised due to their operation outside the lines of the EU regulatory framework. 

The European Securities and Markets Authority (ESMA) is an organization that operates independently from the European Union (EU) and takes the responsibility of regulating financial markets through conducting deep analyses of innovative financial trends and how these trends affect investor protection. The ranking of these innovative trends is more often than not aligned with ESMA goals, and more often than not policy proposals are issued to tackle potential risks. 

The timing of the ESMA report is definitely impeccable considering the wave of financial regulations by the EU, implementation of crypto regulation laws, tax and information reporting requirements and anti-money laundering – AML regulations.

According to the paper, increased volatility in equity markets is due to an increase in risk-taking behavior and market hype.

Retail investors banded together earlier in 2021 to rally behind Gamestop shares, resulting in significant losses for new traders as the price dropped after the movement’s initial rise.

The report indicated that moving forward, risks are foreseen for retail and institutional investors, and market corrections are definitely underway.

The paper warns against the hazards associated with crypto assets, noting that the market value of crypto assets decreased by about 40% in May of this year, showing their extreme price volatility.

Related: Gensler, SEC Chair Notes the Regulations of Crypto to the European Parliament

Stablecoins – The Infamous Malefactors 

Markets in Crypto Assets (MiCA) regulatory framework, according to the report is the up-and-comer framework that will apply in 27 countries addressing stablecoins regulations which may involve a mandate for 3% ownership of coin reserves by issuers.  

In the report, the disliking stance of the EU towards stablecoins is not exactly hidden. 

In the report, the following deliberations come as a result of 49% of reserves were composed of nonspecific commercial paper on Tether:  “market developments around private stablecoins continue to be under scrutiny by global regulators, given the potential impact mass stablecoin adoption could have on financial systems. This call for more transparency and legal certainty has been reinforced as tether, the largest stablecoin, presented a breakdown of its reserves for the first time in May 2021.” 

The EU’s position on stablecoins was clarified last week when Christine Lagarde, ECB President stated that stablecoins are assets masquerading as currencies.

Hazards to the Environment

The report indicated that particular DLT protocols represent an environmental hazard due to large amounts of energy consumption. 

Cryptocurrencies generally and, Bitcoin (BTC) particularly, have come under pressure for the massive quantities of energy necessary to mine and maintain their networks, as pressure rises on global governments and institutions to do more to combat climate change.

According to the report, the carbon footprint from crypto is alarming and not to be ignored. “These developments trigger discussions about possible regulatory responses to the unintended consequences of innovation, and in particular of crypto mining.”

Innovative Financial Trend

Distributed ledger technology (DLT), central bank digital currencies (CBDCs), and decentralized finance (DeFi) are put on a high pedestal by the report as innovative trends, right alongside Artificial Intelligence (AI) and machine learning. 

According to the ESMA report, “DeFi holds the same benefits as blockchain technology on which it is built, namely disintermediation, round-the-clock availability and censorship resistance. It also faces similar challenges and risks, including in relation to operational resilience, scalability and governance.”

The report argues that the use of CBDCs and stablecoins, as well as institutional investors’ greater interest in crypto assets, are blurring the lines between centralized traditional financial institutions and DeFi, raising the possibility of DeFi hazards spilling over into the traditional and real economy.

Also read: Standard Chartered: Bitcoin To $100K In Early 2022

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