Working Paper: CEPR ID: DP17810
Authors: Matteo Aquilina; Jon Frost; Andreas Schrimpf
Abstract: “Decentralised finance” (DeFi) refers to a range of applications in the crypto-asset space that seek to disintermediate the provision of financial services through reliance on self-executing computer code (“smart contracts”). DeFi has so far been mainly self-referential in that it has largely facilitated the financing and trading of crypto-assets rather than providing intermediation services to support real economic activity. Yet this may change in the future, should asset tokenisation and/or the use of DeFi applications by existing financial institutions lead to greater interconnections with traditional finance (TradFi). We argue that many of the functions that DeFi tries to mimic are similar to those in TradFi, and so are many of the risks that this intermediation entails. The same economic rationale that has guided financial regulation for decades can hence be applied to the crypto and DeFi world as well. Risks are, however, often exacerbated in DeFi by the severity of market failures (externalities and information asymmetries). Having compared the functions performed in TradFi and DeFi, we show how regulation to protect consumers, maintain market integrity and ensure financial stability applies to DeFi. Finally, we sketch a possible approach to the regulation of DeFi that takes into account its specificities and functions.
Keywords: Decentralisation; Cryptocurrency; Regulations; Blockchain; Cryptocurrencies; Financial Intermediation
JEL Codes: E42; E51; E58; F31; G28; L50; O32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| DeFi applications (G13) | similar regulatory needs as TradFi (G28) |
| DeFi functions (G13) | need for regulation (G18) |
| market failures in DeFi (D52) | need for regulatory frameworks similar to TradFi (G18) |
| information asymmetries in DeFi (D82) | need for regulation (G18) |
| externalities in DeFi (D62) | need for regulation (G18) |
| lack of regulation (G18) | suboptimal outcomes for consumers and financial system (G21) |
| DeFi's self-referential nature (D53) | limited impact on real economy (F69) |
| future integration with TradFi (G29) | increased financial stability risks (F65) |