DeFi’s amorphous autonomy proves a policy puzzle

Word on the Block | Forkast.News

The decentralized finance sector has undergone phenomenal growth this year, with its value soaring more than tenfold to US$250 billion. But as it becomes too big to fail, its lack of regulatory access points is raising concerns among finance industry observers and finance industry oversight bodies.

“[DeFi] will be difficult to tackle because our current frameworks for financial services are built in the construct of having a financial intermediary in every single financial service provision, and that’s been the access point for the regulators and supervisors,” said Iota Nassr, an economist and policy analyst at the Organisation for Economic Co-operation and Development’s Directorate for Financial and Enterprise Affairs, in a video interview with Forkast.News. “In DeFi, of course, this is non-existent, and this is becoming a big puzzle for us.”

The new paradigm is perplexing not only for policymakers and regulators, but also for many investors, despite its much-lauded attributes of transparency, pseudonymity, and claims to represent a democratization of finance. Nassr points out that the very complexity of DeFi protocols requires esoteric knowledge that remains out of reach for ordinary investors, and which puts better resourced — and, by implication, larger — market participants at a strategic advantage when it comes to benefiting from all that this new industry has to offer.

“We have this paradox where we have absolute transparency, but at the same time, we have the need for some technical, engineering, software development or coding skills which the average user does not have,” Nassr said. She added that this produced a level of opacity that — when coupled with the lack of the customary investor protections found in traditional, regulated financial products — could expose many investors to miscalculations of risk and financial losses.

DeFi’s ability to foster financial democratization — with its inherent promise of inclusion in a finance sector long dominated by Wall Street and institutional players — was not a given, she said, amid the preponderance of those same institutions, alongside family offices and professional investors, in the space.

“We need to be really cautious when arguing for DeFi for financial inclusion, at least at this stage of development,” Nassr said. “For the moment, DeFi activity is concentrated on institutions, and we see a lot of family offices participating in this market to enjoy the leverage opportunities that are available there.”

In Q2 this year, transactions worth US$10 million or more accounted for 60% of all DeFi deals, and Nassr said that if smaller institutional and professional investors were included in that calculus, it would show that almost 95% of total transaction volume in the sector involved non-retail investors.

“Retail users who wish to execute very small-value transactions may be faced with disproportionately high fees, and this is effectively pricing them out,” she said. “This is not to say that there is no potential, but we don’t see this practically happening today.”

A new OECD report entitled “DeFi: Activities, Risks and Why it Matters” is due out in January. Watch Nassr’s full interview with Forkast.News for a sneak preview of its contents.