WHITE PAPER – June 2021
In collaboration with the Wharton Blockchain and Digital Asset Project
Decentralized finance (DeFi) is an emerging and rapidly evolving area in the blockchain environment. Although examples of DeFi have existed for several years, there was a sudden upsurge of activity in 2020. In one year, the value of digital assets1 locked in DeFi smart contracts grew by a factor of 18, from $670 million to $13 billion; the number of associated user wallets grew by a factor of 11, from 100,000 to 1.2 million; and the number of DeFirelated applications grew from 8 to more than 200.2 This growth in turn has stimulated interest from both the private and public sectors.
DeFi aims to reconstruct and reimagine financial services on the foundations of distributed ledger technology, digital assets and smart contracts. As such, DeFi is a noteworthy sector of financial technology (fintech) activity.
However, serious questions remain:
– What, if any, are the distinctive aspects of DeFi? What distinguishes a DeFi service from a similar service based on traditional finance?
– What are the opportunities and potential benefits of DeFi? To whom will these benefits accrue – and who might be excluded or left behind?
– What are the risks – individual, organizational and systemic – of using DeFi? How do these risks apply to clients, markets, counterparties and beyond?
– Can DeFi become a significant alternative to traditional financial services? If so, will there be points of integration? If not, what if anything will DeFi represent in the market?
– What novel legal and policy questions does DeFi raise? How should policy-makers approach DeFi? What options exist for addressing these questions?
Notably, the DeFi space is relatively nascent and rapidly evolving, so the full scope of risks and potential for innovation remain to be seen – and there are unique challenges in regulating and creating policies for such a new and changing area.
This report does not recommend any one single approach; instead, it is designed as a set of tools that can be applied in light of the legal contexts and policy positions of each jurisdiction, which may vary.
In the appendices we offer a series of worksheets and other tools to assist with the evaluation of DeFi activities. A companion piece, DeFi Beyond the Hype, provides additional detail about the major DeFi service categories.
Our hope is that this resource will enable regulators and policy-makers to develop thoughtful approaches to DeFi, while helping industry participants understand and appreciate public-sector concerns.
It is the result of an international collaboration among academics, legal practitioners, DeFi entrepreneurs, technologists and regulatory experts. It provides a solid foundation for understanding the major factors that should drive policy-making decisions.
Download the full report: