New OECD paper criticises “financial engineering” and draws lessons from crypto winter

In a new policy paper titled “Lessons from the Crypto Winter: DeFi versus CeFi,” published on December 14, the Organisation for Economic Cooperation and Development (OECD) examined the crypto winter. The writers investigated the impact of the crypto winter on retail investors as well as the role of “financial engineering” in the industry’s present issues and discovered plenty to dislike.

According to the analysis, institutional market players withdrew their positions earlier than ordinary investors, who may have continued to invest even as the market crashed. TerraUSD (UST) investors, for example, “had no comprehension of the circular and reflexive character of the so-called stablecoin, which had no physical value.” Meanwhile, because of the industry’s tremendous interconnection, contagion spread throughout it.

The OECD paper, which is an intergovernmental organisation with 38 member countries dedicated to economic advancement and global commerce, focused on events in the first three quarters of 2022. It blamed them entirely on a lack of protections as a result of “non-compliant provision of regulated financial activity,” as well as the fact that “some of these operations may fall outside of the present regulatory frameworks in place.”

The crypto winter also “revealed new forms of financial engineering,” which harmed the market. According to the news source:

The authors discuss the CeFi/DeFi crypto divide, noting that DeFi worked “without difficulties” in the first half of the year, however DeFi’s automated liquidations may increase market volatility. Both sorts of platforms may be devoid of oversight or regulatory compliance, and CeFi and DeFi are heavily integrated in a tightly knit ecosystem.

“Developments such as liquid staking and the creation of derivatives backed by illiquid locked assets entail severe liquidity transformation risk and maturity mismatches. Consecutive rounds of re-hypothecation of crypto-assets believed to be lent and/or ‘locked’ as collateral by platform clients generate risks associated with excessive leverage and liquidity mismatches in crypto-asset markets.”
Many of these tactics stem from the “composability” of decentralised finance (DeFi), or the ibility to mix smart contracts to create new products, according to the research, and the abuses continue unabated.

DeFi was determined to have more flaws. The study details an oracle breakdown during the Terra ecosystem collapse, which allowed for abuse on several exchanges. Differences in information access led to DeFi and CeFi platforms behaving noticeably differently during that crisis. According to the report:

The research emphasised the importance of knowledgeable retail investors. “When market participants fail to provide adequate risk disclosure, officials may issue warnings to investors, particularly retail investors, about the increased dangers of such actions,” it stated. There is a lot of uncertainty in the world, and there is a lot of uncertainty.

News Summary:

• New OECD paper criticises “financial engineering” and draws lessons from crypto winter
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