Cryptocurrency and decentralized finance: their functions and impact on financial stability

Author: Matteo Aquilina, Giulio Cornelli, Jon Frost and Leonardo Gambacorta

Translator: Yan Zilin

In April 2025, BIS published the article "Cryptocurrencies and decentralised finance: functions and financial stability implications". This article explores the role of cryptocurrencies and decentralized finance (DeFi) in replicating the core economic functions of traditional finance (TradFi) and analyzes the financial stability risks brought about by their unique mechanisms. The article systematically sorts out key developments such as smart contracts, decentralized exchanges (DEXs), stablecoins, and central bank digital currencies (CBDCs), pointing out that although its basic economic motivations are similar to traditional finance, DeFi has caused new information asymmetry, market failure, and "encryption" of emerging markets. The author proposes that supervision should be designed in a differentiated manner, such as embedding rules in smart contracts and strengthening supervision of stablecoins to mitigate systemic risks. At the same time, the article constructs a prudent regulatory framework that aims to maintain the stability of the financial system while promoting innovation. The study also highlights future research directions such as the enhanced linkage between DeFi and TradFi, the macro impact of "encryption" in emerging economies, and the protection of DeFi market participants. The Institute of Financial Technology of Renmin University of China compiled the core parts of the study.

I. Introduction

Blockchain is regarded as a key innovation in digital data security. Although the concept has been around for decades, the first public blockchain was created in 2008 by an individual or group using the pseudonym "Satoshi Nakamoto". Its official birth date was October 31 of that year, the day the Bitcoin white paper was released. Two months later, the Bitcoin system was officially launched, and its first block was called the "Genesis Block". Since then, crypto assets have experienced multiple rounds of market booms and crashes, which have accumulated a lot of wealth for some early participants, while most retail investors have suffered heavy losses.

Although crypto assets have not yet fully realized the payment function originally envisioned, they have made significant progress since their inception. Multiple new blockchains have emerged, and thousands of crypto assets are built on them. The emergence of the Ethereum blockchain in 2015 is regarded as a key technological breakthrough. It enables developers to deploy decentralized software applications, allowing users to use financial services such as trading and lending without intermediaries.

This range of services is collectively referred to as decentralized finance (DeFi)

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As crypto assets and DeFi develop, regulators and international organizations in various countries have gradually begun to respond to the challenges they bring. Initially, due to the small size of the crypto market, the policy response was mainly limited to warnings about its speculative nature. However, in recent years, as the market expands and its connection with the traditional financial system (TradFi) deepens, policy intervention has gradually increased. At the international level, institutions such as the Bank for International Settlements (BIS), the Financial Stability Board (FSB), the International Monetary Fund (IMF) and the International Organization of Securities Commissions (IOSCO) have issued a number of reports and put forward regulatory recommendations. At the national level, regulators are also becoming more active and have begun to formulate specific policies to deal with the growth of crypto and DeFi.

This chapter aims to explainthe financial functions that crypto assets and DeFi attempt to achieve,covering blockchain, crypto assets, DeFi applications, stablecoins and new central bank currencies,andconstructa conceptual framework for assessing its impact on financial stability,pointing out that the existing traditional financial regulatory framework can also be applied to such innovations after appropriate adjustments. In addition, the paper discusses the necessity of prudent regulation of crypto assets, especially in situations where they are linked to the traditional financial system or need to directly address DeFi risks, and makes a forward-looking assessment of future research directions. 2. Crypto innovation and its financial functions 1. The operating mechanism and usage characteristics of blockchain and crypto assets Blockchain aims to reduce dependence on centralized institutions to verify transactions by combining cryptography with economic incentives. It is essentially an "add-only" distributed database that continuously records ordered data blocks, and some network participants (such as miners or validators) jointly maintain data integrity. Each node holds a complete copy of the blockchain to ensure the decentralization of the network.

In the traditional banking system, fund transfers rely on intermediaries to complete account verification and fund transfers; in the blockchain system, transactions are submitted by users to a pool of pending transactions and broadcast to the entire network. Network participants compete to add new blocks by solving computationally intensive cryptographic puzzles. Once a node completes verification and successfully writes a new block, other nodes can quickly verify and update their local ledgers to achieve network consensus. The new block contains an encrypted summary of the previous block, forming a chain structure to ensure that any tampering requires consensus from the entire network, thereby ensuring that the data is irreversible and tamper-resistant. In order to incentivize nodes to participate in this resource-intensive process, the system provides newly issued cryptocurrencies or transaction fees paid by users as rewards.

Although the original goal of cryptocurrency was to serve as a means of payment, its payment function has not yet been widely realized. In reality, very few households use cryptocurrency to pay for goods or services. In contrast, cryptocurrencies play a more significant role in speculative activities. The sharp fluctuations in prices have attracted a large number of investors seeking high returns. Especially during the period of price increases, the frequency and number of users using crypto trading platforms have increased significantly, showing a high degree of linkage between price trends and investor activity.Overall, crypto assets have been mainly used for high-risk investments rather than daily payments.

2. The structure and function of decentralized finance

After the birth of the Bitcoin blockchain, the crypto ecosystem expanded rapidly. The first major progress was the rise of cryptocurrency exchanges, which enabled users to exchange Bitcoin for fiat currency, attracting a large number of new users and driving price fluctuations. Subsequently, Ethereum was launched in 2015. Its core innovation was the introduction of "smart contracts", which enabled developers to deploy decentralized applications on the chain to achieve conditionally triggered automated transaction execution. This mechanism has contributed to the formation of the decentralized finance (DeFi) ecosystem.

The technical architecture of DeFi can be divided intofour levels: blockchain, smart contracts, protocols and decentralized applications (Dapps).Among them, the protocol is composed of multiple smart contracts and serves specific purposes, such as decentralized transactions, lending, asset management, etc.; while Dapps provide users with an intuitive interface, simplify interaction with the protocol, and are the actual access point in the DeFi system.

The DeFi system attempts to replicate the six core functions of traditional finance: payment and settlement, capital aggregation, cross-period resource allocation, risk management, price discovery and information integration,and mitigation of incentive asymmetry. For example, decentralized exchanges (DEXs) support asset trading without intermediaries, simulating the price discovery function of the market; lending protocols provide fund allocation through overcollateralization; asset management platforms and yield farming enable users to jointly invest and arbitrage between multiple platforms, replicating the fund-raising and asset allocation mechanisms in traditional finance; in addition, derivatives and insurance protocols also correspond to risk management functions.

However, although DeFi highly imitates traditional finance in structure, its role in the real economy is still very limited. Currently, DeFi almost entirely serves the crypto ecosystem and has not yet effectively supported the financing of the real economy, risk hedging, or the commercialization of innovative products. At the same time, DeFi activities are highly speculative, and users mostly participate in transactions with the goal of betting on the appreciation of tokens. This "self-circulating" feature limits its functional extension and also highlights the gap between it and traditional finance in terms of actual performance and economic connection.

3. Types and Functional Evaluation of Stablecoins

Stablecoins are a type of cryptographic tokens that are designed to be exchanged at par with fiat currencies such as the US dollar, with the goal of providing one-to-one redemption capabilities upon demand.Due to their price stability, stablecoins are generally viewed as safer than unsecured cryptocurrencies and are widely promoted as a key medium of exchange in the crypto ecosystem.

According to the different mechanisms for maintaining equivalent value, stablecoins can be divided into three categories:

The first category isfiat-backed stablecoins,

The second category iscrypto-asset-backed stablecoins, such as Dai, which uses cryptocurrencies rather than fiat currencies as collateral to maintain its anchor value, and "decentralized stablecoins" rely on smart contracts to automatically manage crypto collateral.

The third category isalgorithm-backed stablecoins, such as the collapsed TerraUSD, which achieves price anchoring by adjusting the supply of tokens through algorithms. However, in practice, this mechanism is vulnerable to the impact of shaken market confidence and poses serious systemic risks.

Although stablecoins are often promoted as a tool to facilitate cross-border payments and circumvent the high fees in traditional systems, in reality, they are more of an entry tool into the DeFi and crypto markets. In addition, there is no conclusive evidence to support its "safe haven asset" function. Recent studies have shown that more than 90% of fiat-backed stablecoins also experienced capital outflows when facing the impact of the crypto market and US monetary policy, indicating that they cannot provide effective risk mitigation during market turmoil.

4. Development and design of new central bank currencies

In addition to stablecoins, central bank digital currencies (CBDCs) are also rapidly advancing as new digital payment tools around the world. CBDCs are denominated in the national currency and constitute direct liabilities of the central bank. They can be regarded as digital forms of physical cash or commercial bank reserves. CBDCs are mainly divided into two categories: wholesale CBDCs, which are used for transactions between financial institutions, and some of them adopt distributed ledger technology (DLT) and tokenization, which can be regarded as "tokenized central bank reserves"; and retail CBDCs, which are for the public (households and businesses) and are similar to electronic cash in function. Unlike existing electronic currencies, retail CBDCs are directly endorsed by the central bank and have higher credit security. Currently, only the Bahamas, Nigeria and Jamaica have officially launched retail CBDCs, and more than 25 other countries have entered the pilot stage. Studies have found that economies with high mobile technology penetration and strong innovation capabilities have a higher degree of CBDC advancement; retail CBDCs are easier to implement in countries with a large proportion of informal economy, while wholesale CBDCs are positively correlated with the overall level of financial development.

In terms of design, CBDCs show diversity. First, in terms of system architecture, most countries tend to prefer a "hybrid" or "two-tier architecture" model, with the central bank issuing and accounting, and private institutions responsible for customer interface services; a few countries explore a "direct" architecture, which is suitable for inclusive financial goals. Second, infrastructure can adopt traditional centralized databases or distributed ledger technology, and most central banks tend to prefer solutions that balance efficiency and fault resistance. Third, in terms of access mechanism, central banks weigh between the "account system" and the "token system", and most explore the account system or hybrid model: small transactions can be used anonymously, while large transactions require identity recognition. Finally, cross-border use design has also received increasing attention, and more and more projects have begun to consider non-resident use and cross-border payment scenarios.

Overall, the development of CBDC shows that regulators are actively planning to improve payment efficiency, enhance monetary sovereignty and adapt to digital trends, and its design choices also show a comprehensive consideration of technicality, flexibility and policy goals.

Third, the theoretical basis for prudent supervision of cryptocurrencies and decentralized finance

The classic basis for market supervision in economic theory lies in the existence of "market failure", that is, the operating mechanism of the market itself cannot achieve the optimal allocation of resources, and policy intervention is needed to improve overall efficiency. This is especially true for financial markets, which are highly dependent on information symmetry, trust mechanisms and system stability. Once these conditions are destroyed, the market may produce serious externalities, which will in turn have an impact on the entire economy.

This regulatory logic also applies to emerging financial intermediaries such as DeFi. Although the DeFi system adopts an innovative architecture, there are still many potential market failures in its operation, including but not limited to information asymmetry, distorted incentive mechanisms and systemic externalities. For this reason, the crypto-financial sector also needs to implement corresponding prudent supervision to mitigate the risks brought about by these failures, prevent individual behaviors from evolving into systemic shocks, and maintain the stability of the entire financial system.

1. Externalities

Externalities refer to the costs or benefits of a transaction on third parties that are not involved in the transaction. In financial markets, negative externalities can be extremely serious and even lead to the complete failure of financial intermediation mechanisms. Information problems are an important source of externalities, which manifests itself in the fact that the information held by market participants is insufficient to support rational decision-making, or that the information held by one party to a transaction before and after the transaction is asymmetric with that of the other party.

The typical form of externality in financial markets is the "chain reaction of defaults": when one party defaults, its counterparty may also be unable to perform due to losses, thus triggering systemic instability. Due to the core role of the financial system in resource allocation, such chain defaults may spread to the real economy, such as a sharp drop in credit supply, thereby inhibiting economic growth. More importantly, such damage often affects entities that were originally unrelated to the initial default event, making them bear external costs. It is precisely because the cost of default can be externalized that financial institutions often have incentive imbalances and tend to take higher risks.

Financial market volatility events in recent years have shown that chain defaults are not the only channel for externalities. A large number of non-bank financial intermediaries may also become a source of instability, especially in the process of deleveraging, where their asset sales may trigger a downward spiral in prices, forming the so-called "monetary externalities".

Systemic externalities are widely present in various functions of the financial system, especially payment settlement and inter-period resource allocation. If the former fails, it will have a chain reaction on other links in the financial system; the latter is more likely to cause contagion effects when a default occurs due to the high correlation of the credit relationship network. Although DeFi has introduced smart contracts and atomic settlement mechanisms, which have reduced certain types of external risks to a certain extent, important participants in the system (such as stablecoins and their issuers) may still become transmission nodes of systemic risks and need to attract regulatory attention.

2. Information problems

Information problems are widely present in financial markets, mainly in the form of insufficient information and asymmetric information. In the field of crypto assets and decentralized finance (DeFi), these problems are particularly prominent, seriously hindering the effective operation of the market and the rational allocation of resources. 2.1. Insufficient information Insufficient information refers to the lack of key information required for market participants to make rational decisions, which may be due to the lack of disclosure motivation of enterprises or the complexity of financial products themselves. Many financial products have multi-dimensional attributes, and their true quality often takes a long time to emerge. Similar problems are particularly evident in DeFi. For example, the operation of smart contracts depends on specific input conditions, and their behavior will be dynamically adjusted as the economic environment changes, making it difficult for users to predict their future performance. At the same time, investors know almost nothing about the background, technical capabilities or behavioral motivations of the development team behind the Dapp, and even if there is information disclosure, its authenticity and verifiability are difficult to judge.

Another information challenge comes from the use of "oracles". Oracles are responsible for introducing off-chain real-world data into the blockchain for smart contracts to call. However, whether oracles truly comply with the principle of decentralization remains controversial. A fully decentralized oracle system may introduce lengthy and complex consensus mechanisms, thereby reducing transaction efficiency and increasing the system's computational burden, impairing overall performance.

2.2. Information Asymmetry

Information asymmetry can lead to reduced market efficiency, such as reduced output, declining product quality, and even market collapse. In the DeFi ecosystem, product innovation is rapid and the structure is complex. It is difficult for users to effectively distinguish between various service providers based on quality, resulting in the long-term existence of low-quality products and even fraudulent projects. Despite the transparency of price and transaction data on the blockchain, consumers still face problems such as lack of historical information, difficulty in tracking developer reputation, lack of systematic disclosure documents, and lack of effective product comparison methods. In addition, many DeFi applications are based on decentralized autonomous organizations (DAOs) for governance, which have complex internal structures and unclear responsibilities, making it difficult for external users to identify who has substantive decision-making power, who should be responsible for governance results, or who has information advantages over regular users. This further exacerbates the problem of information asymmetry, weakens the foundation of market trust, and increases systemic risks.

3. Mitigation mechanisms for market failure

The existence of market failure does not necessarily mean the necessity of regulatory intervention.In some cases, the market mechanism itself can reduce the impact of failure through technological innovation or structural adjustment, or the failure itself has a small impact and does not require systematic intervention. Therefore, the necessity of regulatory intervention needs to be comprehensively judged in combination with market functions, failure types and existing mitigation measures.

From the perspective of economic functions, DeFi and traditional finance (TradFi) face similar regulatory motivations in many aspects, such as systemic externalities, insufficient and asymmetric information, etc., but there are significant differences in their response mechanisms; in terms of payment and settlement, TradFi mitigates risks through prudent supervision, deposit insurance and the central bank's role as the lender of last resort, while although DeFi can achieve instant settlement, it lacks an effective protection mechanism for systemic assets such as stablecoins; in terms of fund aggregation and allocation, TradFi relies on mandatory information disclosure and trusted intermediaries to protect investors' rights and interests, while DeFi mainly relies on smart contracts and voluntary disclosures (such as white papers), and the information quality and transparency are generally low; in credit functions and risk managementIn terms of price information aggregation and incentive constraints, although DeFi can achieve a certain degree of information integration through on-chain contracts, in actual operation, selective information disclosure is serious and quality control mechanisms are missing.

3.1. Externalities and systemic risks

Market mechanisms have limited ability to correct externalities, especially when private and social incentives are inconsistent. Therefore, TradFi relies on public power intervention to stabilize the system through prudent supervision, risk management requirements, deposit insurance and central bank intervention. In DeFi, the mechanism of stablecoins (especially algorithmic stablecoins) is fragile, and there have been many collapses, which constitute a source of risk contagion to the system.

In addition,the high anonymity in DeFi reduces the reputation constraints of participantsand enhances the motivation for high-risk behavior. The lending relationship relies on highly volatile collateral and lacks a credit mechanism for borrowers. Once the market falls, it will trigger automatic liquidation, which will in turn drive the simultaneous depreciation of collateral assets on other platforms, forming a "price externality" and a systemic feedback loop. The high composability between DeFi protocols further exacerbates the vulnerability of the network. Local node failures may have an amplification effect across multiple networks, causing a larger system impact.

3.2. Information issues and disclosure mechanisms

Although the blockchain itself has a certain degree of information transparency, the DeFi system still has significant shortcomings in alleviating information problems. First, available information does not mean it is understandable or usable. Information disclosure needs to be structured and standardized to help users make rational judgments. In DeFi, disclosure is often in the form of voluntary, non-standardized "white papers", most of which are marketing materials, lack authenticity guarantees, and are not comparable. What's more, the information on the project website is often seriously inconsistent with the terms actually accepted by users.

Second,there are a lot of off-chain information gaps in DeFi,such as the identity of developers, technical background, compliance records, etc. are often hidden, and users cannot identify their credibility or behavioral motivations. More extreme cases are like "rug pulls", that is, developers run away with the money after issuing tokens. Although such incidents also exist in TradFi, at least users can pursue legal responsibility; in DeFi, due to anonymity and cross-border characteristics, accountability is almost impossible, which significantly amplifies the risk of information asymmetry.

To sum up, although the DeFi system has introduced new risk mitigation mechanisms in some aspects (such as atomic liquidation, smart contract execution, etc.), it is still insufficient in terms of information disclosure, risk sharing, governance structure and externality control, and it is urgent to design a regulatory intervention framework that adapts to its structural characteristics.

 Fourth, the conceptual framework of financial stability impact

As pointed out in the previous article, the regulatory logic of traditional finance (TradFi) is also applicable to decentralized finance (DeFi). However, there is an active debate in academia and regulators regarding the challenges posed by crypto assets. The core is how to correct market failures without stifling potential innovation momentum and effectively reducing risks for market participants and the entire financial system. Aquilina, Frost, and Schrimpf (2024b) summarize the current response strategies into three high-level paths: "prohibition", "isolation", and "regulation". The "prohibition" strategy is mainly advocated by those who believe that crypto assets and DeFi have little actual value and pose significant risks to the financial system and consumers. However, this section focuses on the two strategies of "isolation" and "regulation" because a comprehensive ban is neither feasible nor in line with interest considerations. The prohibition strategy is difficult to implement, in part because the global nature of crypto assets allows the industry to be easily transferred to jurisdictions without bans; at the same time, some crypto technologies and DeFi applications do contain beneficial innovation potential and have future application value.

Regarding the "separation" strategy, its goal is to isolate the risks of the traditional financial system from the crypto field. Some supporters advocate that regulators should "let crypto assets fend for themselves" and avoid giving them legitimacy through regulation (Cecchetti and Schoenholtz, 2022a); while the Basel Committee on Banking Supervision (BCBS, 2022) under the Bank for International Settlements is more concerned with preventing the spillover risks of the crypto ecosystem to the traditional financial system.

The "regulation" strategy advocates the use of a regulatory framework similar to that of traditional finance to address the above-mentioned market failure problems (Makarov and Schär, 2022). To explore how to deploy "isolation" and "regulation" strategies, we can start from the four transmission channels of DeFi to the real economy identified by the Financial Stability Board (FSB, 2023a):(i) Financial institutions' exposure to crypto assets, related financial products and entities affected by crypto assets; (ii) Confidence effect; (iii) Wealth effect caused by fluctuations in the market value of crypto assets; (iv) The extent of use of crypto assets in payment and settlement.

In addition, it is worth noting the potential application of smart contracts in traditional finance, the risks of crypto assetization to emerging markets and developing economies (EMDEs), and how to protect the interests of DeFi market participants even in the absence of significant spillover effects. These factors together constitute the key issues for building an effective regulatory and risk isolation framework.

1. The connection between crypto assets and traditional finance and the real economy

Currently, the connection between crypto assets and decentralized finance (DeFi) and traditional finance (TradFi) and the real economy is relatively limited, but it has increased in recent years and may continue to expand in the future. In 2024, the US Securities and Exchange Commission approved Bitcoin and Ethereum-related ETFs, which facilitated investor participation and deepened the connection between banks and brokers and the crypto market.

The tokenization of real assets will also promote the development of this connection, making more assets digitized and traded in DeFi, and traditional financial institutions and infrastructure such as decentralized exchanges may gradually integrate into the mainstream financial system. This will not only expand existing connections, but may also generate new risks and transmission channels. For example, the 2023 US banking stress event was partly due to banks' indirect exposure to large crypto market players.

In terms of prudent supervision, an "isolation" strategy should be adopted to prevent the risks of crypto assets from spreading to traditional finance and the real economy. Financial institutions, especially banks, need to establish a sound risk management mechanism and pay attention to price fluctuations and potential liability risks. In addition, blockchain applications in non-financial fields such as supply chain management should also have the ability to cope with system interruptions and network security risks.

As crypto assets are increasingly integrated with traditional finance and the real economy, relevant regulatory rules should be consistent with traditional finance, including information disclosure, customer identification and professional qualification requirements, and regulators need to obtain sufficient resources and legal authorization. Ensuring that the traditional financial system and the real economy can effectively cope with the impact of crypto assets is the key to reducing overall economic risks. 2. Risks of crypto assets replacing local currencies In emerging markets and developing economies (EMDEs), cryptocurrencies may replace local currencies for real and financial transactions, a phenomenon known as “crypto-assetization”, similar to dollarization and euroization. Due to high inflation or lack of trust in local currencies in some regions, residents and enterprises tend to hold more stable monetary assets or borrow in foreign currencies to enjoy lower interest rates. But this may lead to macroeconomic problems, such as weakened monetary policy transmission mechanisms, economic growth and inflation being subject to foreign monetary policies, and the risk of foreign currency liabilities surging due to local currency depreciation. The risks of crypto-assetization may even exceed those of dollarization and euroization. The widespread use of cryptocurrencies as a means of payment or a store of value may trigger macroeconomic instability and inefficiency. In extreme cases, such as Venezuela and Zimbabwe, high inflation has prompted users to consider cryptocurrencies as an alternative to local currencies. Crypto asset prices fluctuate wildly, and if cryptocurrencies are used in a large number of daily transactions, it may lead to sharp fluctuations in price levels and inflation, and economic performance is affected by speculative demand in global markets rather than domestic fundamentals. The case of El Salvador's attempt to use Bitcoin as legal tender in 2021 shows that there are significant challenges to such practices (Alvarez et al., 2022).

In fact, the adoption rate of cryptocurrencies in some emerging markets has exceeded that of developed countries. Chainalysis (2024) data shows that India, Nigeria and Indonesia have the highest cryptocurrency usage. Local users may conduct actual transactions to avoid risks in the existing financial system and local currencies, or they may speculate. The stablecoins they use are mostly denominated in US dollars or euros, which forms a new channel for dollarization and euroization. Once cryptocurrencies or stablecoins are widely used in actual transactions, fluctuations in any related assets may have a transmission effect on the overall economy. Therefore, regulators may restrict the use of cryptocurrencies to reduce risks through regulations, capital controls and tax measures.

3. Protect market participants in the decentralized finance (DeFi) ecosystem

With the rapid growth in the number of DeFi investors and the scale of funds, regulators are paying increasing attention to investor protection. Supervision should be based on the economic functions achieved by the DeFi protocol, identify specific activities and entities, formulate corresponding rules, and take into account the decentralized characteristics of DeFi. The focus should be on the entities that actually control the DeFi protocol and the decentralized applications (Dapps) that retail users mainly contact. Regulation can rely on two pillars: one is similar to the rules of traditional finance, requiring the disclosure of off-chain information, setting minimum standards for products and services, and professional qualifications of practitioners (such as developers and management teams); the other is to use the on-chain information and the automatic execution function of smart contracts to embed some regulatory rules directly into smart contracts to achieve automatic compliance, such as ensuring the "best execution" of transaction prices and information disclosure. In addition, regulators should pay attention to the overall stability of the crypto ecosystem, especially the role of stablecoins. As the core of the value transfer of the crypto market, the ability of stablecoins to maintain the US dollar anchor is crucial, which requires strict supervision of the types of stablecoin assets and operating mechanisms to ensure that they can be redeemed even under market pressure.

Consumer protection is equally important. Data shows that retail investors tend to chase short-term gains when the market fluctuates, and they were active in trading during the price crash in 2022, while large holders ("whales") were selling and ordinary retail investors ("krill") were buying, reflecting the trend of wealth transfer from small investors to large investors, revealing that the crypto market is not fully inclusive and stable, but may exacerbate wealth inequality.

 V. Conclusion

This chapter analyzed the economic functions of cryptocurrencies and decentralized finance (DeFi), and compared them with traditional finance (TradFi). The results show that the basic economic drivers of DeFi are the same as those of traditional finance, but its unique features - such as smart contracts and composability - bring new challenges, and active regulatory intervention is needed to maintain financial stability while promoting innovation. As the DeFi ecosystem continues to evolve, the following areas deserve further study. First, the interaction between DeFi and traditional finance needs to be strengthened, especially in the context of the tokenization of real assets, the application of smart contracts in traditional finance, and the emergence of new forms of digital intermediaries. The focus should be on assessing the systemic risks that may arise from the integration of DeFi and traditional finance, especially in key areas such as banking and insurance. Secondly, the role of stablecoins in supporting the growth of DeFi and the risks posed by their instability also need to be analyzed in depth, including the assessment of the stability of the DeFi ecosystem itself and its potential spillover to traditional finance. It is particularly important to establish a robust assessment framework. Thirdly, the regulatory impact of fully decentralized protocols and decentralized autonomous organizations (DAOs) remains an open topic. It is necessary to study how DAO governance structures affect financial stability and how regulators respond to truly decentralized systems. Finally, it is necessary to fully understand the macroeconomic impact of the "cryptoisation" of cryptocurrencies in emerging markets and developing economies (EMDEs), and explore how to prevent the risks brought about by the widespread adoption of cryptocurrencies through means such as central bank digital currencies, capital controls and tax policies, while promoting technological innovation. These research directions are of great significance for building a safe and inclusive future financial system.