As diversified finances continue to triumph – although the path is sometimes bumpy – some important questions remain about its nature. How can you protect DeFi applications from becoming unusable under heavy load? Is it really decentralized if some individuals have far more control symbols than others? Does the anonymous culture harm its transparency?
A recent report from the EU Blockchain Observatory and Forum explains these questions and many others around DeFi. It contains eight sections and covers a wide range of topics, from the basic definition of DeFi to technical, financial and procedural risks. The report, prepared by an international team of scientists, sets out some important conclusions that will hopefully catch the eyes of legislators.
Researchers highlight the potential of DeFi to increase the security, efficiency, transparency, accessibility, openness and interoperability of financial services compared to a traditional financial system, and they suggest a new approach to regulation – based on the activities of separate entities further. but their common technical status. The report states:
“As with all regulations, measures should be fair, efficient, effective and enforceable. A combination of self-monitoring and enforced monitoring regulations will gradually give rise to regular DeFi 2.0 emerging from the current emerging DeFi 1.0 ecosystem.
The Cointelegraph spoke with one of the authors of the report, 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 interesting parts of the document.
Cointelegraph: How should regulators approach information asymmetries between professionals and retail users?
Lambis Dionysopoulos: I would argue that this does not require intervention in a regulation. Blockchain is a unique technology in terms of transparency and complex information that it can provide to anyone at no cost. The business of achieving this level of transparency is often important in that distributed blockchains are often criticized as inefficient or unnecessary. However, this is necessary to offer a choice to the current financial system, but its opacity is the root of many evils.
In traditional finance, this opacity is given. The everyday savings bank, philanthropist or voter has no way of knowing whether their funds are conscientiously managed by the bank or supporting their chosen cause, or knowing who supported their politician and how much. DeFi draws the curtain for financial magic by coding all entries in an unchangeable ledger that is accessible to everyone.
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Today, tools like blockchain explorers allow anyone to track the flow of money in the blockchain economy, get information about the apps and services they use in space, and make informed decisions. It is true that those who have the resources and the advanced knowledge can make better use of this system and do so. However, as the DeFi ecosystem expands, I’m optimistic that new tools will emerge that will make more complete insights accessible to anyone. 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 ethics of the DeFi space. The role of regulators should be to facilitate this.
CT: In the report, DeFi is classified as “radical innovation” while fintech is generally “sustaining innovation”. Could you explain these definitions and the differences between them?
LD: Sustained or incremental innovations are improvements to existing products or processes with the goal of better serving the same customers, often for greater profits as well. Fintech is a good example of this. As a result, with e-banking, customers can open accounts faster, start trading online and have access to electronic summaries, reports and management tools.
Revolut and Venmo make it easier to swap bills or ask for allowances. All of these conveniences are often appreciated and demanded by consumers, but also by companies that can find ways to generate revenue. The key to maintaining innovation is the concept of linearity and certainty, which means modest changes that lead to modest improvements in the way things are done as well as added value.
On the contrary, radical innovations such as DeFi are non-linear – they are discontinuous that challenge traditional wisdom. Radical innovations are based on new technologies – they can create new markets and make new business models possible. As a result, they also involve a great deal of uncertainty, especially in the early stages. The idea that anyone can be their own bank and that openness and composition can be overcome on wall gardens is an example of how DeFi can be seen as a radical innovation.
CT: Is there any data that confirms the hypothesis that DeFi can help those who do not have banks and sub-banks? It seems that DeFi is primarily popular among technologically savvy individuals from developed countries.
LD: The idea that DeFi is popular with banking and technology-savvy individuals is both true and short-sighted. For traditional financial services providers, it is a matter of cost and benefit to provide their services to individuals. Simply put, a large part of the planet is not worth their “investment”. Someone more suspicious could also add that depriving individuals of access to funding is a good way to keep them subordinate – looking at who is unbanked could support this alarming theory.
DeFi has the potential to be different. Its international supply does not depend on the decision of the board – that’s how the system is structured. Anyone with basic internet access and a smartphone can access the latest financial services. Modifiability and censorship resistance are also central to DeFi – no one can stop anyone from doing business from or to a specific area or with an individual. Finally, DeFi is the vague 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 Internet – regardless of other social status or other characteristics.
DeFi is popular with technologically savvy individuals for two reasons. First, as a new technology, it requires some technical sophistication and thus attracts users with the luxury of acquiring this knowledge. However, effective measures are being taken to reduce barriers to entry. Social improvement 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, those who adopt early are rewarded with high yields, leaflets (air drops) and price increases. This has attracted technologically advanced and indigenous individuals in finance who seek higher returns on their investments. Market turmoil (such as the recent UST / LUNA events) will continue to separate wheat from wheat, unsustainable high yields will eventually decrease and individuals attracted to them (and only they) will seek profits elsewhere.
CT: The report highlights the difficult aspects of the pseudonym DeFi. What potential compromises between DeFi’s core principles and user safety do you envisage in the future?
LD: DeFi is not completely homogeneous, which means it can provide different services, with different sets of exchanges for different people. Just as blockchains need to compromise either security or decentralization to increase their efficiency, DeFi applications can choose between decentralization and efficiency or privacy and consistency to serve different needs.
We are already seeing several attempts to harmonize DeFi, both in deposit currencies, programmable central bank digital currencies, blockchain securities settlements and much more, collectively also referred to as CeDeFi (centralized decentralized finance). The transaction is directly included in the name. Products with different compromises will continue to exist to serve the needs of consumers. However, I hope that this interview shows arguments for decentralization and security, even if it means challenging practices.
CT: The report states that DeFi has so far had a minimal impact on the real economy, with use cases limited to the cryptocurrency market. What use cases do you see outside of this market?
LD: DeFi has the potential to affect the real world directly and indirectly. Starting with the former, as we become better at making complex technologies more accessible, all DeFi tools can be made accessible to everyone. International payments and transfers are the first low-hanging fruit. The borderless nature of blockchains, combined with relatively low fees and reasonable transaction confirmation times, make them competitors for international payments.
With advances like layer 2, business performance can compete with large financial companies like Visa or Mastercard, making cryptocurrency a compelling option for day-to-day trading. What could follow are basic financial services, such as savings accounts, lending, borrowing and derivatives trading. Blockchain-supported microfinance and renewal funding 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 broader market.
At the same time, the idea of using concepts developed in the DeFi space to increase efficiency in the traditional financial system is emerging. Such use cases include, but are not limited to, smart contracts and programmable money, as well as the use of blockchain’s transparent and transparent features to monitor financial activities and the implementation of more effective monetary policy.
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While each of these individual factors is important in its own right, they are also part of a larger transition to Web3. In that sense, I would argue that the real question is not how much cryptography can affect a ‘real’ economy, but how much it will blur the line between what we consider to be a ‘real’ and an ‘encrypted’ economy.
CT: The report requires recommendations to manage DeFi actors with their functionality rather than using a unit-based approach. How would this regulatory framework work?
LD: In the world of DeFi, units look much different than we are used to. They are not rigidly defined structures. Instead, they are made up of individuals (and individuals as well) who come together in a distributed independent organization to vote on proposals for how the “unit” will participate. Their activities are not well defined. They can resemble banks, payrolls, public squares, charities, and casinos, often all at the same time. DeFi does not have a single party to be responsible for. Due to its global nature, it is also impossible to apply the legislation of one country.
For this reason, our traditional wisdom about financial rules simply does not apply to DeFi. It is more sensible to move to a rule-based activity and this can be facilitated by individual level regulation and DeFi on ramps. That being said, there are definitely bad actors who use DeFi as an excuse to sell repackaged traditional financial products, a little less secure and less controlled – or even worse, outright scams. Regulation can make it more difficult for them to apply for asylum in DeFi.
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