This article provides an overview on the key topics addressed by the DeFi Policy-Maker Toolkit. Interested in more details? The Toolkit as well as the highly recommended accompanying publication “DeFi Beyond the Hype” are open and free to anyone and can be downloaded here:
Decentralized finance (DeFi) is an emerging and rapidly evolving area in the blockchain environment. Although examples of DeFi have existed for several years, a sudden upsurge of activity in 2020 has simulated interest from the private and public sectors.
Over the past year, MME Legal partner Dr. Andreas Glarner has been working with the World Economic Forum, the Wharton University and 50+ other legal, policy making and industry experts to create a DeFi Policy-Maker Toolkit. The Toolkit has been published 8 June 2021 and highlights DeFi’s distinguishing characteristics and opportunities, while also calling attention to the new and existing risks. As well as providing an overview of the DeFi space generally, it maps out the potential legal and regulatory responses. The result of an international collaboration among academics, legal practitioners, DeFi entrepreneurs, technologists and regulatory experts, the report provides a solid foundation for understanding the major factors that should drive policy-making decisions.
This article provides an overview on the key topics addressed by the DeFi Policy-Maker Toolkit. Interested in more details? The Toolkit as well as the highly recommended accompanying publication “DeFi Beyond the Hype” are open and free to anyone and can be downloaded here:
Download Toolkit: https://weforum.ent.box.com/s/9059vh7c40w7550fw9gfupxdubcrr4ph
Read “DeFI Beyond the Hype": http://wef.ch/defitoolkit
The Toolkit aims to be a clear, concise, and neutral guide for policy-makers and regulators interested in the quickly-evolving decentralized finance space. Thereby, it:
Provides an overview of the DeFi space generally, and the major classes of DeFi protocols, with tools to help understand the implications of new services
Explores the potential benefits of the DeFi approach, along with the challenges that DeFi businesses will face
Offers a detailed breakdown of the risks that DeFi may pose. Many of these are familiar concerns (although sometimes manifested differently), while others are unique to the decentralized, programmable and composable structure of DeFi
Maps out potential legal and regulatory responses
to DeFiTo achieve these goals, the Toolkit in particular includes the following Policy-Maker Tools:
DeFi Distinguishing Characteristics,
Architecture, Service Categories
Case Studies
Decision Tree
Background Assessment
Stakeholder Mapping Tool
Decentralization Spectrum
DeFi Policy-Maker Canvas
While the space is evolving quickly, the Toolkit offers a functional description to distinguish DeFi from traditional financial services and auxiliary services. A DeFi protocol, service or business model has the following four characteristics:
Financial services or products
Trust-minimized operation and Settlement
Non-custodial design
Programmable, open and composable architecture
Thereby, the DeFi “stack” includes:
Base-layer blockchain system
Assets (digital assets, stablecoins, etc)
Optional Gateway (wallets)
Application layer (decentralized exchanges, credit, derivatives, insurance)
Aggregation layer (DEX aggregators, asset and yield management)
Auxiliary services (oracles, indexing and query, storage)
The toolkit provides a risk mapping framework covering 17 risks divided into five categories:
Financial Risk: Depletion of funds due to the transactional behaviour of fellow users concerning the digital assets in the DeFi service.
a) Market risk
b) Counterparty risk
c) Liquidity risk
Technical Risks: Failures of the software systems supporting transaction execution, pricing and integrity.
a) Transaction risk
b) Smart contract risk
c) Miner risk
d) Oracle risk
Operational Risks: Failures of the human systems for key management, protocol development or governance.
a) Routine maintenance and upgrades
b) Forks
c) Key management
d) Governance mechanisms
e) Redress of disputes
Legal Compliance Risks: Use of DeFi to engage in illicit activity or to evade regulatory obligations.
a) Financial crime
b) Fraud and market manipulation
c) Regulatory arbitrage
Emergent Risks: Macro-scale crashes or undermining of the financial system due to the interaction, scaling and integration of DeFi components.
a) Dynamic interactions
b) Flash crashes or price cascades
The Toolkit provides a range of policy actions may be adopted for DeFi, including:
The Toolkit specifies various policy tools that are available to address DeFi and associated risks.
a) Specialized regulatory units
b) Incentivizing information flow
c) Regulatory sandboxes
d) Clarifying easy cases
e) Coordinating government action