The Organization for Economic Co-operation and Development (OECD) analyzed the crypto winter in a new policy paper titled “Lessons from Crypto Winter: DeFi vs. CeFi” released on 14 December. The authors examine the impact of crypto winter on retail investors and find much to like and not the role of “financial engineering” in the industry’s current problems.
The paper from the OECD, an intergovernmental body with 38 member countries dedicated to economic progress and world trade, focused on events in the first three quarters of 2022. It blamed their “non-compliance” on a lack of safeguards. provision of regulated financial activity” and the fact that “some of these activities may fall outside the existing regulatory framework in some jurisdictions.”
The report noted that institutional market participants exited their positions sooner than retail investors, who would have continued to invest even after the market declined. Investors in TeraUSD (UST), for example, had “little understanding of the circular and reflexive character of a so-called stablecoin with no tangible value.” Meanwhile, the infection spread across the industry due to high interconnectivity.
The crypto winter also “uncovered new forms of financial engineering” that had a negative impact on the market. according to the report:
“Developments such as liquid staking, creating derivatives backed by illiquid locked assets, create extreme liquidity variation risks and maturity mismatches. Frequent rounds of re-mortgaging of crypto-assets that are considered loans and/or ‘locked’ by platform clients as collateral create risks related to high leverage and liquidity mismatches in crypto-asset markets.
The report notes that many of those practices stem from the “creation” of decentralized finance (DeFi), which is the ability to combine smart contracts to create new products, and the practices continue.
1/ Excellent new research on the role of the OECD #cefi And #defi In crypto turmoil. #crypto Advocates may try to blame the centralized players, but let’s not ignore the role of DeFi. Smart contract flaws + leveraged trading fueled volatility. https://t.co/EVCRhp3y0a pic.twitter.com/lWA2PeUclw
— Brian Laverdure, You (@brian_laverdure) December 14, 2022
The authors delve into the CeFi/DeFi divide within crypto, noting that DeFi operated “without issues” in the first half of the year, although the automatic liquidation of DeFi could lead to more volatility in the market. Both types of platforms may lack regulation or regulatory compliance, and CeFi and DeFi are highly intertwined in a centralized ecosystem.
Related: OECD Releases Framework to Combat International Tax Evasion Using Digital Assets
More flaws found in DeFi. The report documented an oracle failure during the Terra ecosystem collapse, which created opportunities for abuse on some exchanges. DeFi and SeFi platforms behaved markedly differently during that crisis due to differences in information access. The report mentioned:
“CeFi and DeFi markets do better in bull markets.”
The report stresses the need for educated retail investors. “Policy makers may caution investors, and in particular retail investors, about the increased risks of such activities when proper disclosures about the risks are not made by market participants,” it said. It added that as the industry develops, crypto market woes will be more likely to spread to traditional markets, and that international coordination will be necessary “to address regulatory arbitrage opportunities currently exploited by some non-compliant crypto-asset firms”. to protect.”