The European Securities and Markets Authority (ESMA) has warned that closer links between crypto markets and traditional finance could increase the risk of contagion across Europe’s financial system. The regulator said the crypto downturn and expanding connections between markets require closer monitoring.

In its second risk monitoring report for 2026, issued on 10 September, ESMA classified market, contagion and operational risks at their highest level. The regulator said crypto market value has continued to decline since the beginning of 2026, with almost €2 trillion lost since the end of October. Crypto has also shed nearly €2 trillion in market value since its October highs, according to ESMA.

ESMA said the crypto sector is becoming increasingly interconnected with other financial markets. That relationship is significant because a decline in Bitcoin and other crypto assets may extend beyond the crypto market itself. Financial institutions, investment products and tokenized assets could provide channels through which losses spread across markets.

The regulator did not make an outright prediction of a market collapse. Instead, it said that volatile crypto trading markets, combined with potentially stronger connections to traditional finance, could heighten the risk of spillover effects.

ESMA’s news release and second 2026 risk monitoring report address the regulator’s assessment.

DeFi Exploits Add to Interconnectedness Risks

The report also referenced decentralized finance (DeFi), where recent successful hacks have renewed concerns about interconnectedness. DeFi protocols can depend on multiple smart contracts, liquidity pools, bridges and other applications. If one part of that network fails or is breached, losses or failures may spread to other components.

ESMA’s analysis indicates that the issue extends beyond the volatility of individual tokens. As more capital and participants move between crypto and traditional markets, the way the industry is structured is becoming increasingly relevant to overall financial stability.

Tokenization Brings Crypto Closer to Traditional Finance

ESMA also highlighted tokenization. Although tokenized equities remain much smaller than traditional equity markets, their use is growing. This development could create stronger links between blockchain-based financial instruments and traditional markets.

The regulator said the increase in on-chain financial assets will require monitoring of their interactions with existing institutions, trading venues and investors. Tokenization may expand blockchain’s applications beyond cryptocurrencies, but it could also make market structures more interdependent. This means that regulators will be watching not only individual digital assets, but also how these assets interact with established financial infrastructure.

ESMA further noted that retail investors remain exposed to risks from digital platforms, social media and speculative trading. Inexperienced traders may be more vulnerable to false information and rapid decision-making, particularly when platforms make trading more convenient.

The report was published as the European Union continues developing regulations for digital assets. According to ESMA’s current assessment, risks from crypto-assets continue to grow rapidly despite increased scrutiny as the digital asset industry evolves.

Source: CryptoNinjas