The crypto ecosystem: key elements and risks

1. Introduction
The market capitalisation of the crypto ecosystem – notwithstanding a significant decline in 2022 – lies in
the trillions of dollars, and there are thousands of crypto coins in circulation. The spread of crypto has
been global in nature and driven by a wide range of investors.
In theory, the crypto universe builds on the premise of decentralisation. Rather than relying on
central bank money and trusted intermediaries, crypto envisages that the recordkeeping of transfers is
provided by a multitude of anonymous validators. Decentralised finance, or “DeFi”, seeks to replicate
conventional financial services in a decentralised way within the crypto universe, often underpinned by the
medium of exchange role of stablecoins. DeFi incorporates innovations such as programmability and
composability on blockchains. Such systems are “always on”, allowing for worldwide transactions 24
hours per day, seven days per week.
Recent events revealed a wide divergence between the crypto vision and reality. Although crypto
operates under the banner of decentralisation, in practice new centralised intermediaries have played a
key role in channelling funds into the crypto universe and intermediating within it. The implosion of the
FTX crypto exchange is only the most notable manifestation of the sector’s vulnerabilities. Rather than
providing a more resilient financial architecture, crypto displayed the same well known vulnerabilities of
traditional finance, but in amplified ways.
This report reviews the key elements of the crypto ecosystem and assesses its structural flaws. It
then goes over the risks that it poses and discusses options for addressing them. It also identifies data
gaps and discusses ways to alleviate them.
The report has three key takeaways. First, the crypto ecosystem is subject to a high degree of
fragmentation and is characterised by congestion and high fees. This would have been the case even if it
had stayed true to its original decentralised ethos. These structural flaws derive from the underlying
economics of incentives of validators rather than from technology. And while crypto has offered some
elements of genuine innovation, these can be replicated or embedded in the safer and more trusted
traditional finance system (BIS (2023)). Second, despite an original ethos of decentralisation, crypto and
DeFi often feature substantial de facto centralisation, which introduces various pain points. A prime
example concerns stablecoins, which piggyback on the credibility of the central bank’s unit of account and
may pose risks to monetary sovereignty. Third, while DeFi mostly replicates services offered by the
traditional financial system, it does not finance any activity in the real economy but amplifies known risks.
As growth is driven mainly by the speculative influx of new users hoping for high returns, crypto and DeFi
pose substantial risks to (especially retail) investors. In sum, crypto’s inherent structural flaws make it
unsuitable to play a constructive role in the monetary system (BIS (2022)).
2. The key elements of the crypto ecosystem
This section describes the main components of the crypto ecosystem. It begins by tracing the development
of Bitcoin and blockchain technology. It then discusses the growing role of centralised intermediaries in

 the ecosystem. In particular, it discusses stablecoins, which are most often issued by centralised entities
and grew from a bespoke solution to the inherent volatility of crypto assets to becoming a pillar of the
crypto ecosystem. The section concludes with a discussion of smart contracts and the decentralised finance
applications that build on them. The technical terms used throughout this report are defined in the
Glossary.
2.1 Unbacked crypto
The birth of crypto dates to the introduction of Bitcoin in 2009: a decentralised, peer-to-peer means of
transferring value on a shared public ledger (ie a public blockchain using distributed ledger technology
(DLT)). In its original formulation, crypto was characterised by not being backed by any asset, as well as by
a stated claim to reduce the influence of intermediaries through decentralisation (Nakamoto (2008)).
Ownership of crypto assets and transactions with them are verified by decentralised validators
and recorded on the public ledger. If a seller wants to transfer cryptoassets to a buyer, the buyer (identified
through their cryptographic digital signature) broadcasts the transaction details, eg transacting parties,
amount or fees. Validators (in some networks called “miners”) then compete to verify the transaction, and
whoever is selected to verify appends the list of transactions to the blockchain and is compensated in fees
paid in cryptoassets. The updated blockchain is then shared among all miners and users. In this way, the
history of all transactions is publicly observable and tied to specific wallets, while the true identities of the
parties behind transactions (ie the owners of the wallets) remain undisclosed. In this sense, transactions
on blockchains are pseudo-anonymous. By broadcasting all information publicly, the system verifies that
every transaction is consistent with the history of transfers on the blockchain, eg that the cryptocurrency
actually belongs to the seller and has not been spent more than once.
As cryptoassets started attracting broader attention from potential investors, centralised entities
played a greater role in channelling funds into crypto coins. In particular, centralised exchanges, which
facilitated the conversion between Bitcoin, other cryptoassets and fiat money, contributed to rising crypto
prices by attracting new participants, in a self-reinforcing loop. Centralised intermediaries (notably
platforms such as Mt Gox in the early days, and more recently Binance, Coinbase, Kraken and FTX until its
sudden collapse in late 2022) have reasserted their key role in the crypto ecosystem time and time again.
This system has come to be known within the crypto space as centralised finance (CeFi), and its ups and
downs have contributed to the volatility of cryptoasset prices (Graph 1.A).
2.2 Stablecoins
Stablecoins have established themselves as the main medium of exchange within the crypto ecosystem
and as a gateway into it. They are so-called because they aim to maintain a stable value relative to a
specified asset or pool of assets. Stablecoins are usually pegged to a numeraire, almost always the US
dollar, but can also target the price of other currencies or assets (eg gold or even other cryptoassets). In
this way, they seek to overcome high volatility and low liquidity to play the role of a medium of exchange
in the crypto universe. Stablecoins also play a key role in the DeFi ecosystem (see next section).
Stablecoins come in two main types, depending on how they attempt to maintain their peg (FSB
(2022)). Most stablecoin arrangements are managed by a centralised intermediary and are “asset-backed”.
The underlying assets can include US government bonds, short-term corporate debt or bank deposits. The
centralised intermediary invests the underlying collateral and coordinates the coins’ redemption and 

The crypto ecosystem: key elements and risks