DeFi draws the curtain for financial magic, says EU Blockchain Observatory expert
While decentralized finance continues its triumphant march – although the road is sometimes bumpy – some important questions remain about its nature. How can DeFi applications be protected from being out of order under extreme stress? Is it really decentralized if some individuals have far more control symbols than others? Does the anonymous culture compromise its openness?
A recent report from the EU Blockchain Observatory and Forum elaborates on these questions and many others around DeFi. It contains eight sections and covers a range of topics, from the basic definition of DeFi to its technical, financial and procedural risks. Carried out by an international team of researchers, the report formulates some important conclusions that will hopefully find their way into the eyes and ears of legislators.
The researchers highlight Defi’s potential to increase the security, efficiency, transparency, availability, transparency and interoperability of financial services compared to the traditional financial system, and they propose a new approach to regulation – one based on the activity of separate actors rather. than their shared technical status. The reports say:
“As with any regulation, measures should be fair, effective, efficient and enforceable. A combination of self-regulation and supervised enforcement will gradually give rise to a more regulated DeFi 2.0 emerging from the current incipient DeFi 1.0 ecosystem. “
Cointelegraph spoke with one of the report’s authors, Lambis Dionysopoulos – a researcher at the University of Nicosia and a member of the EU Blockchain Observatory and Forum – to learn more about the most exciting parts of the document.
Cointelegraph: How should regulators approach information asymmetry between professionals and retailers?
Lambis Dionysopoulos: I would argue that there is no need for regulatory action for that. Blockchain is a unique technology in the level of transparency and intricate information it can provide to anyone at no cost. The trade-offs to achieve this level of transparency are often significant to the extent that decentralized blockchains are often criticized as ineffective or redundant. However, this is necessary to provide an alternative to the existing financial system, whose opacity is the root of many evils.
In traditional finance, this opacity is given. The everyday saver, charity donor or voter has no way of knowing if their money is dutifully managed by the bank or supporting their preferred cause, or knows who sponsored their politician and by how much. DeFi draws the curtain for financial magic by coding each transaction on an immutable general ledger that is accessible to all.
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Today, tools such as blockchain researchers allow everyone to track the cash flow in the blockchain economy, get information about the apps and services they use in space, and make informed decisions. It is true that those with the means and advanced knowledge can, and do, benefit better from this system. But as the DeFi ecosystem expands, I’m optimistic that new tools will emerge that will make more advanced insights available to all. My optimism is based on two factors: First, it is relatively easier to build such tools in DeFi; and secondly, inclusion and openness is the ethos of the DeFi room. The role of regulators should be to facilitate this.
CT: In the report, DeFi is classified as “radical innovation”, while fintech is generally “sustainable innovation.” Can you explain these definitions and the difference between them?
LD: Maintenance or incremental innovations are improvements to existing products or procedures with the goal of better serving the same customers, often for a higher profit as well. Fintech is a good example of this. As a guide, through e-banking, customers can open accounts faster, initiate online transactions and access electronic bank statements, reports and management tools.
Revolut and Venmo make it easier to split the bill or ask for pocket money. All of these conveniences are often welcomed and demanded by consumers, but also by companies that can find ways to make money on them. Central to maintaining innovation is a notion of linearity and security, which means modest changes that result in modest improvements in how things are done, as well as added value.
On the contrary, radical innovations like DeFi are non-linear – they are discontinuities that challenge conventional wisdom. Radical innovations are based on new technology – they can create new markets and enable new business models. For this reason, they also involve a high degree of uncertainty, especially in the early stages. The notion that anyone can be their own bank and that openness and composability can overcome fenced gardens are examples of how DeFi can be perceived as a radical innovation.
CT: Is there any data that confirms the hypothesis that DeFi can help those who do not have a bank and subbank? It seems that DeFi is first and foremost popular with technology-savvy individuals from developed countries.
LD: The notion that DeFi is popular among banking and technology savvy individuals is both true and short-term. For traditional financial service providers, making their services available to an individual is a matter of cost-benefit. Simply put, a large part of the planet is not worth its “investment”. Some who are more suspicious may also add that depriving individuals of access to finance is a good way to keep them subordinate – a look at who they are without a bank can support this frightening theory.
DeFi has the potential to be different. Global accessibility does not depend on the decision of a board – it is how the system is built. Anyone with rudimentary internet access and a smartphone can access state-of-the-art financial services. Immutability and censorship resistance are also central to DeFi – no one can stop someone from shopping from or to a specific area or with an individual. Finally, DeFi is agnostic about the intentions behind sending or receiving information. As long as someone sends or receives valid information, they are first-class citizens in the eyes of the network – regardless of their other social status or other characteristics.
DeFi is popular with technically savvy individuals for two main reasons. First, as an incipient technology, it requires a certain level of technical sophistication and thus attracts users with the luxury of acquiring this knowledge. However, active measures have been taken to reduce barriers to entry. Social recovery and advances in UX design are just two such examples.
Second, and perhaps most importantly, DeFi can be lucrative. In the early stages of wild experimentation, early users are rewarded with high returns, payouts (airdrops) and price increases. This has attracted technology-savvy and financially-born individuals who seek higher returns on their investments. Market shocks (such as the recent events in UST / LUNA) will continue to separate wheat from the cliff, unsustainably high yields will eventually decline, and individuals attracted to them (and only them) will seek profit elsewhere.
CT: The report highlights the problematic aspects of the pseudonymous culture of DeFi. What possible compromises between the core principles of DeFi and the safety of users do you see in the future?
LD: DeFi is not completely homogeneous, which means that it can offer different services, with different sets of trade-offs for different people. Similar to how blockchains need to compromise either security or decentralization to increase efficiency, DeFi applications can make choices between decentralization and efficiency or privacy and compliance to meet different needs.
We are already seeing some attempts at compatible DeFi, both in deposit-stable coins, programmable central banks’ digital currencies, securities settlement using blockchain, and much more, collectively also referred to as CeDeFi (centralized decentralized finance). The balance is explicitly included in the name. Products with different trade-offs will continue to exist to meet consumer needs. However, I hope this interview makes a case for decentralization and security, even if it means challenging conventions.
CT: The report states that DeFi has so far had a minimal impact on the real economy, with use cases limited to crypto markets. What use cases do you see outside these markets?
LD: DeFi has the potential to affect the real world directly and indirectly. From the former, as we become better at making complex technologies more accessible, the entire suite of DeFi tools can be made available to anyone. International payments and remittances are the first low-hanging fruit. The boundless nature of blockchains, along with relatively low fees and affordable transaction confirmation times, make them a competitor to international payments.
With advances like layer 2, transaction flow can compete with major financial providers such as Visa or Mastercard, making cryptocurrency a compelling alternative for daily transactions as well. What may follow are basic financial services, such as savings accounts, lending, borrowing and trading in derivatives. Blockchain-supported microfinance and regenerative financing are also gaining ground. In the same way, DAOs can introduce new ways of organizing communities. NFTs can also be, and have been, more attractive to the wider market.
At the same time, the idea of using concepts developed in the DeFi room wins to increase the efficiency of the traditional financial system terrain. Such use cases include, but are not limited to, smart contracts and programmable money, as well as the use of blockchain’s manipulative and transparent properties to monitor financial activity and implement more effective monetary policy.
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Although each of these individual components is important in its own respect, they are also part of a larger transition to Web3. In that regard, I would argue that the real question is not how much crypto can affect the “real” economy, but how much it will blur the line between what we consider “real” and “crypto” economics.
CT: The report provides a reserved recommendation to regulate DeFi players according to their activity instead of using a device-based approach. How would this regulatory structure work?
LD: In the DeFi world, devices look much different than what we are used to. They are not rigidly defined structures. Instead, they are made up of individuals (and also entities) who come together in decentralized autonomous organizations to vote on proposals for how the “entity” will be involved. Their activities are not well defined. They can look like banks, clearing houses, a public square, charities and casinos, often all at the same time. In DeFi, no single device can be held responsible. Due to its global nature, it is also impossible to apply the legislation of a single country.
For this reason, our conventional wisdom with financial regulation does not apply to DeFi. Switching to an activity-based regulation makes more sense and can be facilitated by regulation at the individual level and the DeFi access ramps. That said, there are definitely bad actors who use DeFi as an excuse to sell repackaged traditional financial products, only less secure and less regulated – or worse, outright fraud. Regular security can make it more difficult for them to seek asylum in DeFi.
