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DeFi or the decentralized finance industry has the potential to disrupt mainstream banks, as per experts. But the Bank for International Settlement (BIS) have deemed that the industry has a centralization issue and lawmakers should use that to regulate the sector. In a recent published quarterly review the bank highlighted the first of its five special features to discuss the decentralized and implications for financial stability. According to the report, the decentralized industry seeks to enhance the efficiency of financial transactions with automated contracts developed on blockchains. Notably, BIS revealed that there is a way from which lawmakers can enter in the industry.
DeFi requires centralized governance
According to the report of BIS, the DeFi industry has an unpreventable requirement for a centralized governance. According to Hyon Song Shin, BIS’ head of research, there is a limit to how far someone can run an entire financial system that is based on automated transactions. Hence, there would be events where the decentralized projects would need reorganization or judgment.
Following the scenario, Shin concerned how far could the industry go without a centralized guidance. DeFi’s current governance system has the tendency for blockchain consensus mechanisms, which also allows a small count of stakeholders to make bigger decisions. Hence, although the industry widespreads, its vulnerabilities could undermine financial stability.
Emerging vulnerabilities in the decentralized ecosystem
According to the 16-page feature report shared by BIS, vulnerabilities in the DeFi industry arise from intermediary-free lending programs. Moreover, such issues can also arise from liquidity concerns in stablecoins.
On the other hand, some of the vulnerabilities also include connectedness among decentralized applications (dApps) and lack of banks to absorb potential shocks.
DAOs can help lawmakers to enter
DeFi industry is known for its decentralized nature, which is concerning for lawmakers. On the other hand there are governance tokens that are digital assets representing voting power in the industry. The holders of these governance tokens can influence any protocols by voting or proposing for new changes. Notably, these governing bodies are known as decentralized autonomous organizations (DAOs) that can oversee multiple projects.
According to the report, DAOs are the one element of centralization that can serve as the basis of recognizing the projects in the industry as legal entities similar to tangible corporations. Following the rapid growth of the industry, the report asked the lawmakers to start taking steps. BIS also believes that regulatory protections would help ensure the innovative potential of the decentralized industry which is beneficial for our financial world.