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Decentralized finance (DeFi) is likened to the Archetypal Old West.
Dream time
The International Monetary Fund has a message to the government. Find a way to regulate your DeFi platform for cryptocurrency trading and lending before the risks to your global financial system go out of control.
The IMF made that call in its latest Global Financial Stability Report released this week. This document outlines a range of risks to the global financial system, including the “shock wave from the war in Ukraine” and the dangerous combination of inflation, debt and monetary policy.
Cryptography also has a spot on the wall of concern. “The wider use of crypto assets in emerging markets can undermine domestic policy objectives,” said Tobias Adrian, IMF’s financial counselor, in a summary of the report.
Cryptographic ecosystems may allow individuals or groups to circumvent sanctions, the report said. Bitcoin mining can also help countries avoid sanctions and enable them to “monetize energy resources.” According to the report, Russia and Iran could have earned a total of 15% of the world’s mining revenues, reaching $ 1.4 billion last year.
This week, the Treasury added Russian miner Bitriver to the list of sanctions. “Russia has a comparative advantage in cryptocurrency mining because of its energy resources and cold climate,” the Treasury said in a news release.
In a broader sense, the IMF sees an increasing risk of decentralized financial stability. The DeFi platform consists essentially of “smart contracts,” which are software code that sets the terms of a transaction. They are fully automated and do not rely on centralized entities for market making, liquidity, payments, or storage services.
Users typically borrow stablecoins (tokens designed to maintain a fixed value) and provide volatile cryptography such as:
ether
Also
Bitcoin
As collateral for a loan. Stablecoin is then used for transactions and is often used as collateral for long or short bets on another crypto. Lenders are compensated by the yield of tokens offered to the “liquidity pool” at a rate set by market supply and demand.
The system aims to incorporate automatic clearing resulting from collateral requirements and collateral shortages, or lender protection if the loan-to-value ratio falls below a preset threshold.
According to the site DeFi Llama, DeFi has exploded with over $ 215 billion in “value locks” on the platform, up from less than $ 1 billion two years ago. The IMF warns that its success is why DeFi has become another risk to the stability of the financial system.
“DeFi is often leveraged and especially vulnerable to markets, liquidity and cyber risk,” says the IMF.
DeFi is also expanding into the world of institutional investors as the platform develops ways to attract large investors and creates more links and mechanisms that can impact traditional finance. The IMF also warned that DeFi could “accelerate the ongoing trend towards cryptography” in some economies, replacing traditional currencies and potentially damaging state monetary policy. ..
In the IMF’s view, the solution is to crack down on DeFi enablers (centralized exchanges, wallet providers, stablecoin issuers). Authorities can also review and audit the software that manages smart contracts. Request disclosure from the DeFi platform. Establish more governance in the industry, potentially through self-regulatory organizations. Another option is to limit exposure to the DeFi platform by regulated entities such as cryptocurrencies with the goal of “slowing down the pace of growth.”
Some of these proposals have already begun in Washington. The Biden administration has ordered federal agencies to devise a framework for regulating cryptography by the fall. The European Union is developing rules to combat illegal transfers on crypto networks and has recently passed a broad regulatory framework for the industry.
DeFi is called “Wild West” by US regulatory agencies. The IMF didn’t describe it that way, but it’s one of several financial oversight agencies that are now demanding to ride a sheriff.
Write a letter to Daren Fonda at daren.fonda@barrons.com
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