As the technology continues to evolve, so too do the applications that it manifests. Decentralised Finance (DeFi) has grown exponentially over the last 3 years with December 2021 seeing the Total Value Locked (TVL) reach an all-time high of US$106.105 billion, grabbing the attention of policymakers and regulators worldwide.
DeFi promotes the proposition of completely removing intermediaries and in its place handing over control of the protocol to a Decentralised Autonomous Organisation (DAO), who issues governance tokens to participants of the DAO to make decisions on matters such as code application and maintenance. With the legal status of a DAO uncertain, it has posed a challenge for policy makers and regulators where existing financial services legislation is based on an accountable intermediary.
DeFi offers a great opportunity for financial markets with savings to be made through, faster, better, cheaper and more efficient financial services and as such has caught the attention for its use institutional grade products as well as a way of unlocking capital for SME investment. However, there are hurdles to cross in the form of needing to garner trust through improving transparency and preventing illicit activity.
Whilst no one has made significant progress to address DeFi to date, the EU has indicated that it plans to introduce rules on DeFi before the end of 2023. An indication of their approach has been published in the May report on ‘European Financial Stability and Integration Review 2022’. The UK is also looking for solutions to tackle potential risks associated with DeFi, which has recently been highlighted in a report published by the Bank of England on ‘Financial Stability in Focus: cryptoassets and decentralised finance’. Although these are only early stages, the rate of acceleration of the industry will certainly promote a strong response from governments across the globe.