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EU Regulator Warns About Risks of DeFi

In recent days, numerous reports have been published about the cryptocurrency ecosystem. The latest one? A report from the European Securities and Markets Authority (ESMA) on the inherent risks of using DeFi.

The European Securities and Markets Authority warns about the risks of DeFi

The report, published last Wednesday, aims to be somewhat educational as it clarifies certain themes and subdivides the vast world of DeFi into several sections. Indeed, it is undeniable that this emerging field is full of complexity.

Firstly, the report explains that although investors’ exposure to DeFi is generally low, there are serious risks to investor protection due to the highly speculative nature of many DeFi agreements, important operational and security vulnerabilities, and the absence of a clearly identified responsible party.

Another important point highlighted by the institution is the use of the famous saying ‘Code is law.’ According to them, ‘adhering to this principle leads to accepting the results of smart contracts regardless of any moral or legal considerations.’

However, ESMA readily acknowledges that the absence of intermediaries combined with the automated and immutable functions of smart contracts is one of the strengths of DeFi. Nevertheless, it laments the pseudonymity of developers which, according to them, ‘can facilitate the proliferation of illicit smart contracts.’

Lastly, the report expresses concern about the risks of contagion in the event of a DeFi protocol failure. It explains that ‘the composability feature of smart contracts, which allows DeFi protocols to be built on top of each other, providing a variety of services for users, also creates dependencies between protocols, leading to a risk of contagion.’

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