BIS: DeFi could shape the future of finance, but it’s too complex

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Decentralized finance (DeFi) harnesses innovative technology and could shape the future of finance. However, it’s too technologically and economically complex, and a deep understanding of DeFi is still lacking in the market, a new paper by the Bank for International Settlements (BIS) says.

In its paper, BIS defined DeFi as “a competitive, contestable, composable, and non-custodial financial ecosystem built on technology that does not require a central organization to operate and that has no safety net.” DeFi targets financial disintermediation, with users only interacting with smart contracts and not central entities.

BIS has been anti-DeFi for years, stating in December that it was more fragile than advertised and poses “formidable challenges for tax enforcement, aggravates money laundering issues and other kinds of financial malfeasance.”

In its new paper, it now claims that DeFi is too complex for most people. It further pointed out that DeFi, despite claims of decentralization, is still subject to the same risks that traditional finance has faced for centuries.

“Furthermore, the promises of transparency and stability in DeFi are not necessarily guaranteed, as is exemplified by investigations into the Tether stablecoin,” the paper noted.

In the paper, the BIS delved in detail into a settlement in DeFi, the use of digital assets, the different DeFi protocols—which include decentralized exchanges, lending protocols, and derivatives protocols—and DeFi compositions.

BIS concludes that regulators can no longer dismiss DeFi as digital assets continue to become integrated into the mainstream financial system.

The DeFi paper came just a week after the BIS called on regulators to ban, contain or regulate digital assets. The bank believes that central banks can also lure users away from digital assets by making TradFi more attractive. The Brussels-based bank pointed out that central bank digital currencies (CBDCs) are a good starting point and can lead to sound financial innovation.

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