ESMA Warns of Growing Links Between Crypto and Finance

The links between crypto and traditional finance are becoming significant enough to attract more attention from the European regulator. In its risk monitoring report published on September 10, ESMA calls for close monitoring of this interconnection. Tokenized stocks, DeFi, and predictive markets are directly mentioned. The regulator does not yet speak of an established systemic risk, but of new channels capable of transmitting a crypto shock to the rest of the financial markets.

In Brief

• ESMA is monitoring the rapprochement between the crypto market and traditional finance.
• Tokenized stocks and DeFi exploits are among the identified risks.
• Predictive markets also pose issues of manipulation and insider trading.

Crypto and Traditional Finance Are Becoming Less Separate

The formula used by ESMA is quite clear. The regulator calls for increased monitoring of the growing link between crypto markets, which it deems "increasingly vulnerable," and the broader financial system.

Tokenized stocks are one of the examples highlighted. Their weight remains negligible compared to global stock markets. However, their adoption is progressing and is bringing new infrastructures, new investors, and new intermediaries into the same circuit.

ESMA had already detailed its reservations regarding tokenized stocks, particularly when the token does not grant exactly the same rights as the traditional stock it represents.

The change in tone is interesting. In March, ESMA still wrote that the adoption of tokenization remained limited, with relatively low volumes and narrow applications. It already acknowledged progress and possible advantages: faster settlement, automation through smart contracts, or the use of traditional assets in DeFi.

Six months later, adoption remains early. But the topic now also appears in the section on financial transmission risks. The boundary is shifting.

DeFi Exploits Can Now Exceed Just Crypto

DeFi constitutes the second point. ESMA mentions recent exploits of protocols as a renewed source of concern regarding interconnection and possible spillover effects. It does not provide, in its statement, a precise list of the incidents responsible for this concern.

The mechanism is quite simple. As long as a DeFi protocol only manipulates purely crypto assets, a loss remains primarily concentrated within that ecosystem. Things change when the same protocols welcome tokenized stocks, money market funds, private credit, or other assets from traditional finance.

A compromised smart contract can then affect assets whose value and counterparties are outside the blockchain.

This is precisely the rapprochement that ESMA is monitoring. The issue also extends beyond Europe. The OECD has identified this year the growth of connections between crypto and traditional markets as a potential contagion risk, particularly through stablecoins and their reserves in traditional financial assets.

This does not mean that a DeFi attack would today trigger a European financial crisis. ESMA does not assert this. It rather states that the more the two systems use the same assets and actors, the harder it becomes to consider their risks separately.

Tokenization is precisely accelerating this convergence. Cointribune recently noted that tokenization is becoming a major project for financial institutions.

Predictive Markets Add Another Problem

The third issue is less related to credit or liquidity risk. It concerns market integrity. According to ESMA, predictive markets can present increased risks of insider trading, wash trading, and coordinated manipulation. The use of crypto infrastructures can also complicate the detection of some of these practices.

The regulator had already begun to take an interest in this before this new report. In July, it reminded that certain contracts based on a binary outcome may fall under existing European rules on binary options. It all depends on the product and the underlying event. Some contracts may also fall under national gaming law.

It was then explained how ESMA regulates predictive markets in Europe. However, the sector has continued to grow. Platforms now allow betting on elections, economic decisions, sporting events, or legislative texts. For ESMA, the issue is therefore no longer just whether a token falls under MiCA or whether a DeFi protocol operates without intermediaries. Crypto is beginning to share more assets, liquidity, and users with traditional finance. For now, ESMA speaks of monitoring and vulnerabilities, not of a crisis in progress.