BIS Report: Rising Crypto Activity Poses Financial Stability Risks

The BIS report indicates that cryptocurrencies and DeFi have reached critical levels, posing risks to financial stability and increasing wealth inequality. The report highlights the need for stricter regulations in DeFi, including KYC requirements. It identifies key transmission channels for risk while suggesting a framework of regulation rather than prohibition to address emerging risks stemming from the integration of crypto into the traditional financial system.

The Bank for International Settlements (BIS) has released a report indicating that cryptocurrencies and decentralised finance (DeFi) have reached a significant level of activity, presenting possible challenges to financial stability. The report identifies the expanding links between cryptocurrencies and traditional finance (TradFi), driven notably by the introduction of Bitcoin exchange-traded funds (ETFs) and the tokenisation of real-world assets (RWAs).

BIS economist Raphael Auer co-authored the report, which discusses how these advancements have altered exposure levels for traditional financial institutions. The interaction between brokers, asset managers, and crypto markets suggests that the divide between TradFi and DeFi is becoming increasingly blurred.

A notable concern highlighted in the report is the disparity in investor behaviour during downturns. Retail investors tend to enter the market during adverse conditions while institutional investors often withdraw, potentially exacerbating wealth inequality as losses disproportionately affect smaller investors who tend to adopt crypto later.

BIS identifies four key transmission channels that could jeopardise financial stability: direct exposure of TradFi to crypto entities, shocks to market confidence, volatility in wealth due to price fluctuations, and the usage of crypto for transactions. While these channels have not yet triggered systemic issues, they are becoming critical conduits for increased risk.

The report raises a pressing issue regarding the potential for cryptocurrencies to widen wealth inequality. Data shows that retail investors tend to increase their crypto exposure in times of stress, whereas institutional investors typically reduce theirs, leading to a transfer of wealth towards affluent early adopters of cryptocurrency.

In addressing the regulatory landscape, BIS proposes a “contain and regulate” approach rather than an outright ban. This method suggests that imposing TradFi-style regulations—such as Know Your Customer (KYC), transparency obligations, and licensing—on DeFi platforms could help alleviate risks to the wider economy. The UK’s initiative for a new legal category to govern protocol operators exemplifies this growing global movement towards accountability in decentralized ecosystems.

The report also highlights that tokenisation of RWAs could draw more traditional financial actors into DeFi, increasing overall systemic risks. Since stablecoins play a crucial role in DeFi activities, their potential destabilisation should be a focal point for regulatory efforts. Additionally, the rising dependency of emerging markets on crypto—termed “cryptoisation”—presents significant risks that call for a coordinated international policy response.