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BIS called DeFi’s decentralization an illusion

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Decentralized finance (DeFi) has a centralization problem that policymakers need to take advantage of to regulate the sector. The new quarterly report of the Bank for International Settlements (BIS) contained this conclusion.

Thus, the report says that DeFi has an “inescapable need” for centralized management.

“The point raised in the special feature is that there’s a limit to how far you can run a whole financial system purely based on those automated transactions. I think it’s an open question how far this project can be pushed without that kind of centralized guidance. I think that’s something that we will clearly need to watch very carefully”. Said Hyun-Song Shin, economic adviser and head of BIS research.

The interaction of regulators with DAO and management token holders will help solve issues

Shin expressed confidence that there will be cases when DeFi will require reorganization or evaluation. Furthermore, the governance structures inherent in protocols are obvious starting points for public policy, the report says.

Analysts doubted that DeFi could destroy a larger financial system, despite the rapid growth. They admitted that as DeFi became more popular, financial stability could be threatened due to “severe vulnerabilities” of the protocols.

The BIS also noted that the thesis of full decentralization in DeFi does not stand up to criticism. At the same time, the introduction of management tokens and DAO can weaken it.

According to Shin, the interaction of regulators with DAO and management token holders will help solve issues of consumer protection, prevention of money laundering. As well as maintaining financial stability. This will limit the risks associated with DeFi before the sector dramatically increases in size.

Risks of using borrowed assets in one protocol as collateral in another

The report mentions the possibility of concentrating decision-making powers in the protocols in the hands of a small group of large investors.

Separately, experts noted the risks of using borrowed assets in one protocol as collateral in another. Which may cause pressure on token prices during the liquidation period. Regarding stablecoins, BIS pointed out the risk of a “bank run” in terms of providing commercial securities that do not have liquid secondary markets. As an example, they cited Tether (USDT).

With regard to algorithmic stablecoins like DAI, analysts noted the market risk of their supported assets. The value of which may fall sharply below the nominal value of the stablecoin. In this case, there is no fallback option in the form of banks that can provide liquidity in times of stress, they added.

BIS allowed a reduction in the “distance” between DeFi and traditional finance. Due to the desire of the participants of the latter to master cryptocurrencies. Which can create an overflow effect.

Regulatory safeguards

BIS has called on national banks to start making moves for the unregulated sector.

“Regulatory safeguards would also help to ensure that the innovative potential of DeFi brings overall benefits to finance,” the experts concluded.

Recall that earlier, FATF published the final version of the guidelines for the crypto industry; with a focus on DeFi and non-fungible tokens (NFTs). FATF introduced the first version of the manual in June 2019. Then Bitcoin exchanges and other Virtual Asset Service Providers (VASPs) were obliged to comply with the rules on combating money laundering and terrorist financing by analogy with traditional financial companies.

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