Key Elements of an Effective DeFi Framework

Abstract

Decentralized Finance (DeFi) is a rapidly growing but nascent industry. It utilizes blockchain technology to add functionality to the next iteration of the Internet–Web3, that empowers consumers and businesses to use financial services in a cost efficient and independent manner, and provides them with an opportunity to participate in a new financial system. If properly developed and deployed, the proliferation of DeFi will lead to greater financial inclusion, consumer participation, and market efficiencies than the legacy financial system.

At the time of writing, the total market capitalization of DeFi projects is approximately $42 billion (with an all-time high of approximately $173 billion) while total value locked (TVL) in such projects sits at approximately $38 billion (with an all-time high of approximately $178 billion). While these nominal amounts are not large when compared to total amounts in the global financial system, DeFi’s exponential growth, along with its novel approach to financial services, have caught the eyes and concerns of policymakers around the globe.

The G20, the Financial Stability Board, and other international standards setters, along with central banks, regulators, and finance ministries worldwide are currently studying how DeFi works and its benefits and risks. However, DeFi is often misunderstood both as a concept and as a sector. We at the Crypto Council for Innovation (CCI) prepared this white paper to contribute to the public discourse on DeFi.

As policymakers consider regulatory approaches to DeFi and the challenges to regulating decentralized financial services that have no obvious entities in control, we put forward a regulatory approach to DeFi that mitigates financial safety and soundness concerns, and financial stability risks, while also protecting consumer end-users and fostering innovation. We outline critical elements for an effective DeFi regulatory framework that are feasible, suitable, and proportionate for regulators and DeFi innovators.

Keywords: DeFi, decentralized finance, DeFi regulation, crypto regulation, cryptoassets, digital assets, financial regulation, TradFi, DeFi risks, DeFi benefits, DeFi protocols, DeFi protocol risks, Public Good Protocols, DeFi applications