Decentralized Finance DeFi – ‘Decentralized Finance’ – has joined FinTech, RegTech, cryptocurrencies and digital assets as one of the most discussed emerging technological evolutions in global finance. Yet little is really understood about its meaning, legal implications and policy consequences.
This article introduces DeFi, puts DeFi in the context of the traditional financial economy, connects DeFi to Open Banking and ends with some policy considerations.
We suggest that decentralization has the potential to undermine traditional forms of accountability.
In addition, erode the effectiveness of traditional financial regulation and enforcement.
At the same time, we find that where parts of the financial services value chain are decentralized.
Moreover, there will be a reconcentration in a different (but possibly less regulated, less visible and less transparent) part of the value chain.
As a result, DeFi regulation could and should focus on this reconcentrated portion of the value chain to ensure effective oversight and risk control.
Rather than eliminating the need for regulation, in fact DeFi requires regulation in order to achieve its core objective of decentralization: decentralization arguably requires centralization of some form in order to be successful in most cases.
Furthermore, DeFi potentially offers an opportunity for the development of an entirely new way to design regulation.
Moreover, the ideas of ’embedded supervision’ and ‘embedded regulation’ – building regulatory approaches into the design of DeFi, potentially decentralizing both finance and its regulation in the ultimate expression of RegTech.
‘Decentralized Finance’ (‘DeFi’) is neither a legal nor a technical term.
It is nonetheless used increasingly in the context of discussions about the future evolution of finance and its regulation.
Common usage incorporates one or more elements of:
- (1) decentralization
- (2) distributed ledger technology and blockchain
- (3) smart contracts
- (4) disintermediation
- (5) open banking
While decentralized systems such as Bitcoin rely on distributed ledger technology (DLT) and blockchain to underpin token-based ecosystems, the combination of DLT and blockchain is not the only way to achieve decentralization.
Furthermore, many distributed ledgers (and most distributed ledgers operated by large financial intermediaries) operate today with a hierarchical, centralized governance model, limiting accessto permissioned participants.
In turn, decentralized does not necessarily mean distributed.
Universite du Luxembourg – Faculty of Law, Economics and Finance; Heinrich Heine University Dusseldorf – Center for Business & Corporate Law (CBC); European Banking Institute
The University of Hong Kong – Faculty of Law; University of Hong Kong
University of New South Wales (UNSW) – Faculty of Law
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