To enable policymakers to overcome the hype of Decentralized finance (DeFi) that took the world by storm over the past year, the World Economic Forum (WEF) in collaboration with Wharton business school, has launched a toolkit to examine the opportunities and risks, this new technology could bring.
Decentralized finance (DeFi) is a rapidly growing field in the blockchain ecosystem and we are seeing a surge in its adoption from 2020 onwards (“DeFi Summer”). Both private and public sectors have shown simulated interest in this domain.
DeFi’s origin can be traced from the early launch of decentralized stable coin DAI by Maker foundation in 2017. DeFi enables anyone to have easy and more direct access to financial services via smart contracts.
Fundamentally, DeFi is about providing universal access to financial services and tools. It’s a set of financial systems and protocols that you can access on the internet, and the crucial thing is that everyone gets to access it on the same terms.Rune Christensen, co-founder and CEO of MakerDAO
In the past year, the total number of DeFi applications grew from eight to more than 200 now and the total number of associated user wallets increased to 1.2 million from 100K. The total value locked (TVL) in decentralized finance (DeFi) continues to grow, rising from under $1 billion to over $80 billion in less than 18 months. This surge made some of its own founding leaders become the industry’s biggest critics and skeptics. Such growth triggers the need for more education for people involved in the sector and WEF is aiming to fill that information asymmetry.
DeFi can offer a greater financial benefit to 1.7 billion people in the world who don’t have access to traditional banking. However, it comes with its own risk such as the potential for scams and issues in smart contracts leading to massive losses. The World Economic Forum (WEF), in collaboration with the Wharton School of the University of Pennsylvania, is now publishing a framework to help policymakers evaluate DeFi and map out possible regulatory responses.
The toolkit presents DeFi’s distinguishing characteristics and opportunities and also highlights its new and existing risks. It also gives a general overview of the DeFi ecosystem and maps out the potential legal and regulatory responses. This toolkit is the result of an international collaboration among academics, legal practitioners, DeFi entrepreneurs, technologists, and regulatory experts, the report provides a solid foundation for understanding the major factors that should drive policy-making decisions.
We have recently witnessed many DeFi hacks and flash loan attacks where companies and investors have lost millions of dollars. On Binance Smart Chain alone there were more than eight flash loan hacks that happened in May 2021 alone.
A lot of people are doing scams because a lot of people are interested in DeFi, so if you slap the word DeFi on anything, you will get a lot of money coming your wayMarc Fleury, CEO and co-founder of fintech company Two Prime, in an interview with Forkast.News
The WEF DeFi toolkit includes case studies as well as flowcharts and worksheets that identify a few risks that it says policymakers should bear in mind when it comes to building DeFi. For example, policymakers should be aware of the “market risk,” when asset value could decline over some time horizon due to market conditions, new information or traders’ idiosyncratic behavior, and “liquidity risk” — a possibility that there could be insufficient funds available to cover asset withdrawals.
Hopefully, that kind of framework where governmental and private institutions come together and work together towards a better regulation [that] would enhance change and appreciate the creative destruction we are facing, rather than defending ourselves from it.Aušrinė Armonaitė, minister of the economy and innovation of Lithuania
WEF worked with many government bodies in creating the DeFi toolkit. The government of Colombia, among one, has also expressed interest in using it for DeFi policymaking and WEF hopes to work hand in hand with more governments over the course of the next six months to a year “to see what they need to really move the needle on some of these policymaking and regulatory questions.”