The Bank for International Settlements (BIS) says that the tokenization of real-world assets (RWAs) on blockchains will develop stronger links between crypto and traditional finance (TradFi).

In a new paper on the financial stability risks of crypto, BIS analysts say that RWAs – or the tokenization of traditional assets on distributed ledgers – are creating an increased connection between TradFi and decentralized finance (DeFi).

If the trend continues, the BIS says that more and more assets will be traded in the DeFi ecosystem, to the point that “the self-referential nature of DeFi will become a characteristic of the past.”

Such a development would likely make DeFi infrastructure much more mainstream than it is today, says BIS.

“A much larger set of institutions could start participating and a number of infrastructures that are currently specific to DeFi, such as DEXs (decentralized exchanges), will become part of the mainstream.

As a result of these changes, not only will the existing connections grow in size, but they will evolve in ways that are difficult to predict. There may already be connections in areas that are not immediately obvious. For instance, the drivers of the March 2023 banking stress are difficult to pinpoint exactly. But the indirect exposure of US banks to depositors with large stakes in crypto markets was a contributing factor which took many policymakers and supervisors by surprise.”

The international financial institution calls for more research and a deeper look into the regulation of the connection between DeFi and TradFi in order to quell potential stability risks in the event of “spillovers.”

“As the DeFi ecosystem continues to evolve, several areas warrant deeper exploration. First, the interaction between DeFi and TradFi needs more attention, especially as tokenization of real-world assets, the use of smart contracts in TradFi and new forms of digital intermediation emerge.

Research could focus on understanding the potential systemic risks if DeFi becomes more integrated with TradFi, particularly in critical sectors like banking and insurance. Second, the role of stablecoins in supporting DeFi’s growth and the risks posed by their instability require further analysis, spanning both the stability of the DeFi ecosystem itself and its potential spillovers with TradFi.”

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