Financial Stability at Stake Decentralised Finance's Regulatory Challenges in a Changing Financial Landscape

This article considers the potential of decentralized finance (DeFi) to disrupt global financial stability, highlighting its evolving vulnerabilities and emerging systemic risks. While DeFi has yet to trigger a financial crisis, its rapid growth, increasing complexity, and expanding interconnections with traditional finance (TradFi) suggest that it could become a channel for financial instability under stress conditions. While DeFi inherits certain vulnerabilities of TradFi, its reliance on decentralized governance, algorithmic execution, and volatile collateral arrangements generates distinct risk dynamics. The article places a critical emphasis on stablecoins, whose structural fragilities and liquidity mismatches may amplify contagion effects in times of market stress. The article also examines the limitations of built-in risk mitigation mechanisms, such as overcollateralization and automated liquidation, which, in the absence of legal safeguards or supervisory oversight, may not be sufficient to prevent market-wide disruptions. To mitigate the threat that DeFi may pose to financial stability, this article identifies two regulatory priorities: enhancing monitoring and supervision of DeFi’s evolution and fostering international cooperation to mitigate transmission risks inherent in the DeFi ecosystem.