Central Banks See DeFi Decentralization as ‘Illusion’

The Bank for International Settlements says although DeFi appears to be decentralized, there are "entry points" for regulators to implement policies.
Matthew HellerDecember 9, 2021

Banking regulators may be able to address the vulnerabilities of decentralized finance even though it does not operate through traditional middlemen such as banks and exchanges, according to the Bank for International Settlements.

In a report, the umbrella group for central banks said that “the main vision of DeFi’s proponents is intermediation without centralized entities” and this decentralized structure “raises the question of how to implement any policy provisions.”

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However, “full decentralization in DeFi is an illusion,” the BIS said, noting that “platforms have groups of stakeholders that take and implement decisions, exercising managerial or ownership benefits.”

“These groups, and the governance protocols on which their interactions are based, are the natural entry points for policymakers,” the report suggested. “These entry points should allow public authorities to contain DeFi-related issues before this ecosystem attains systemic importance.”

The report comes as DeFi continues to grow rapidly, with the market capitalization of stablecoins increasing from a little more than $20 billion a year ago to more than $130 billion today.

In the U.S., the federal government’s top financial regulators called last month for stricter oversight of stablecoins, citing concerns over market integrity, investor protection, and illicit finance.

“Failure to act risks growth of payment stablecoins without adequate protection for users, the financial system, and the broader economy,” the President’s Working Group on Financial Markets warned.

The BIS said DeFi’s vulnerabilities “are severe because of high leverage, liquidity mismatches, built-in interconnectedness, and the lack of shock-absorbing capacity” and that “If the attendant risks are not well managed, stablecoins are prone to runs, which would compromise their ability to transfer funds within the DeFi ecosystem.”

“In addition, possible fire sales by a stablecoin of its reserve assets could generate funding shocks for corporates and banks, with a potentially severe impact on the broader financial system and the economy,” the report said.

Timo Lehes, a co-founder of decentralized crypto exchange Swarm Markets, said numerous institutions in the space are already working to address the systemic issues flagged by the BIS. “There’s much to gain from operating within regulatory frameworks established to protect investors and maintain access to markets,” he told CNBC.