The following article provides an overview of the key topics presented and explained in DeFi's Policy-Maker Toolkit. For more details, the Toolkit and the highly recommended accompanying publication, "DeFi Beyond the Hype", are available and free for everyone to download from the links below.
I. Toolkit for creating decentralized finance (DeFi) policies was created thanks to the cooperation of Wharton Blockchain and the Digital Asset Project.
Decentralized Finance (DeFi) is an emerging and rapidly growing area in the cryptocurrency and blockchain technology environment. While examples of DeFi projects have been around for several years, the sudden spike in activity in this area during 2020 has sparked interest from both the private and public sectors.
The DeFi Policy Making Toolkit was released on June 8, 2021. It incorporates the distinctive features and capabilities of DeFi while highlighting some new and existing dangers to the rapid development of decentralized finance projects. The above-mentioned study, apart from a general overview of the DeFi space and a description of its elements, also presents potentially usable legal responses, as well as regulatory postulates. The report, which is a direct result of international collaboration between scientists, lawyers, entrepreneurs creating applications based on DeFi, technologists and regulatory experts, provides a solid foundation for recognizing and understanding the main factors that should guide political decisions.
The following article summarizes the most relevant topics covered and analyzed in the DeFi Policy-Maker Toolkit. The Decentralized Finance Policies Toolkit and the highly recommended and accompanying publication "DeFi Beyond the Hype" are open and free to everyone and can be downloaded here:
Download: Toolkit: https://weforum.ent.box.com/s/9059vh7c40w7550fw9gfupxdubcrr4ph
Read: https://wifpr.wharton.upenn.edu/wp-content/uploads/2021/05/DeFi-Beyond-the-Hype.pdf
While the technological environment in the area of decentralized finance is changing rapidly, the toolkit offers a functional description to distinguish DeFi from traditional financial services and related services. It should be noted here that the DeFi protocol, services or business model has the following four characteristics:
- they qualify as financial products or services
- operations between users take place without the need for a high degree of trust between the parties to the transaction
- DeFi projects are non-custodial protocols
- these are programmable protocols with open source code and composable architecture
Accordingly, the DeFi "stack" includes the following features:
- the system used to create DeFi protocols is blockchain technology
- digital assets such as tokens or stable coins are functionally related to most DeFi protocols
- cryptocurrency wallets are "gateways" used to connect to DeFi protocols
- the most popular layers of DeFi applications include decentralized exchanges, loan protocols, insurance and synthetic financial instruments
- at the level of aggregation, DeFi protocols are most often characterized by asset and profit management
- DeFi space is characterised by a wide sector of support services such as oracles
The Decentralized Finance Toolkit aims to provide a clear, concise and neutral guide for policymakers and regulators interested in creating a legal framework for the DeFi sector. Thus, the purpose of this document is:
In order to achieve all of the above objectives, the Toolkit specifically includes the following tools for policy makers:
The DeFi Toolkit includes a risk identification framework covering 17 types of risks, which are divided into five categories:
a) Market risk
b) Counterparty risk
c) Liquidity risk
a) Transaction risk
b) Smart contract risk
c) Miners' risk
d) Risk related to the work of the oracle
a) Routine maintenance and updates
b) Forks
c) Key management
d) Management mechanisms
e) Settlement of disputes
a) Financial crimes
b) Fraud and market manipulation
c) Regulatory Arbitration
a) Dynamic actions
b) Lightning-fast breakdowns or price cascades
The Toolkit contains a number of policy demands that can and should be adopted for DeFi, including:
The Toolkit provides a range of tools that are available to regulate the DeFi sector and its associated risks.
Transition mechanisms: it can be expected that policy approaches can be based on how the digital content was initially addressed. During the initial boom in ICO offerings in 2017, few regulators had the structures or expertise to deal with the phenomenon, as - seemingly out of nowhere - significant capital was pouring into new platforms that claimed to be outside regulatory boundaries. Some of the regulatory solutions for ICO offers may prove useful in the context of DeFi. These can include:
a) Specialized regulatory units
b) Encouraging the flow of information
c) Regulatory sandboxes
d) Coordination of government activities
Regulation of the life cycle of new technologies:
Where the legislator does not perceive a clear risk initially, regulation usually appears later in the life cycle of a new technology or service, when the damage that may result becomes more probable. Regulators are more inclined to adopt a 'do no harm' approach in the beginning, given the relatively small scale and innovative potential of emerging technologies. For products with clearly known risks or misapplications, the industry is tightly regulated and all steps are carefully supervised and controlled. Technological systems like DeFi tend to avoid regulatory radars, but only temporarily. The Eberhard Advisory team offers you their expertise in the field of new financial technologies such as DeFi.
