DeFi

Decentralised Finance or ‘DeFi’ is an effort to replicate certain functions of the traditional financial system in an open, decentralised, permissionless and autonomous way, based on blockchains¹ . On the DeFi ecosystem, innumerous platforms and protocols are deployed to enable both innovative and traditional financial products and services, without the need of a central trusted entity such as a central bank or a financial institution. This is done through decentralized applications (DApps).

Authorities must be vigilant to tackle the risks stemming from DeFi, particularly regulatory arbitrage vis-à-vis TradFi, excessive risk taking, cybersecurity risks, poor disclosure, asset ownership opacity and redress mechanisms. Financial stability and spillover can be a concern in the future, in case adoption goes up without appropriate risk management. Several options exist to properly integrate DeFi into the current regulatory framework² . Among these, authorities can bring entrant DeFi protocol operators into current financial regulation, strengthen oversight over licensed financial institutions that venture into DeFi or even introduce a licensing regime for DeFi protocols.

With risks properly supervised and managed, the possible effect of DeFi over DFS competition is three-pronged. Firstly, innovative technologies, products and services launched in the decentralized ecosystem could be moved to the TradFi environment, after some centralization to comply with the regulatory framework currently in place. Secondly, consumers could increase adoption of DApps and their products in the DeFi marketplace, potentially reducing usage of less efficient DFS. Finally, incumbents from TradFi could make partnerships or even acquire DeFi players, thus being able to offer the newly-procured services in their channels or linking them to currently-offered services. The increased gamut of DFS and providers present opportunities for smaller transaction costs and reduction of rents by dominant actors.