Europe: The European Securities and Markets Authority warns of growing links between crypto assets a

The linkage between crypto assets and traditional finance has attracted great attention from European regulators.

The increasingly close connection between crypto assets and traditional finance is important enough to attract more attention from European regulators. In a risk monitoring report released on September 10, the European Securities and Markets Authority (ESMA) called for close monitoring of this interconnection and directly named tokenized stocks, decentralized finance (DeFi) and forecasting markets.

Although regulators have not yet characterized it as an established systemic risk, they note that these new channels have the ability to transmit the impact of the crypto market to other financial markets.

Quick overview of core points

• ESMA is closely monitoring the convergence trend between the crypto market and traditional finance.
• The popularity of tokenized stocks and DeFi protocol vulnerabilities are seen as identified risk points.
• Forecasting the market also has hidden dangers such as market manipulation and insider trading.

The boundaries between crypto and traditional finance are blurring

The wording used by ESMA is clear: Given its view of the crypto market as "increasingly fragile," regulators have called for greater monitoring of the growing links between the crypto market and the broader financial system.

Tokenized shares are one of the cited examples. Although its weight in global stock markets is still negligible, its adoption rate is gradually increasing, introducing new infrastructure, new investors, and new intermediaries into the same ecological cycle.

We have previously elaborated on ESMA's reservations about tokenized stocks, especially when the rights represented by contemporary coins are not completely consistent with their traditional counterparts. The change in tone is noteworthy: In March this year, ESMA said that the adoption of tokenization is still limited to a small scale, with relatively low transaction volumes and narrow application scenarios, but also acknowledged the progress and potential advantages it brings, such as faster settlement speeds, automation of smart contracts, and the use of traditional assets to enter the DeFi space.

Six months later, although adoption is still in its early stages, the topic is now classified as financial risk transmission. The border is shifting.

The impact of DeFi vulnerability may spill beyond the realm of encryption

DeFi constitutes a second concern. ESMA cited recent protocol vulnerabilities as a renewed source of concerns about interconnectivity and potential spillover effects. In its statement, it did not provide a precise list of specific incidents that led to this concern.

The mechanism is quite simple: as long as the DeFi protocol only handles purely cryptographic assets, losses are mainly concentrated within the ecosystem. However, the situation changes when the same protocol administers tokenized stocks, money market funds, private credit, or other assets derived from traditional finance. Once a smart contract is compromised, it may affect assets whose value and counterparties are located outside the blockchain.

This is exactly the convergence phenomenon that ESMA is monitoring. This problem is not limited to Europe. The Organization for Economic Cooperation and Development (OECD) this year also pointed to the growth of connectivity 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 today's DeFi attacks will lead to the European financial crisis. ESMA does not claim this. It highlights that as the two systems use more of the same assets and behavioral entities, it becomes increasingly difficult to consider their risks separately. Tokenization is a key factor in accelerating this integration. Cointerbune recently pointed out that tokenization is becoming a major project for financial institutions.

Predicting new compliance challenges brought by the market

The third issue has little to do with credit or liquidity risk, but rather with market integrity. According to ESMA, it is predicted that the market may have increased risks of insider trading, knock-on trading and coordinated manipulation. The use of cryptographic infrastructure may also make the detection of certain behaviors more complex.

Regulators have begun to focus on this area before the release of the new report. In July, it warned that certain contracts based on binary outcomes could fall within existing European binary options rules. It depends on the nature of the product and the underlying events. Some contracts may also be governed by national gambling laws.

We have previously explained how ESMA regulates Europe's forecasting markets. Despite this, the industry continues to grow. Today's platforms allow users to bet on elections, economic decisions, sporting events or legislative text. For ESMA, the issue is no longer just whether a token falls under MiCA regulations or whether a DeFi protocol operates without intermediaries. Crypto assets are beginning to share more assets, liquidity and users with traditional finance.

Currently, the focus of ESMA's talk is still surveillance and vulnerability rather than ongoing crises.