Decentralized finance (DeFi): the ultimate regulatory frontier?

Abstract

Decentralized finance (DeFi) refers to the use of blockchain technology, specifically cryptocurrencies and smart contracts, to create a permissionless, open-source and transparent financial services ecosystem that is available to everyone and operates without the need for intermediaries, such as banks or brokers. The origins of DeFi projects can be traced back to in 2017, with Maker DAO (decentralized autonomous organization) being amongst one of the first significant DeFi projects incorporating stablecoin, decentralized governance and lending protocols. Initially, DeFi’s progress was slow, but it gained momentum rapidly in 2020, with the emergence of advancements in projects such as Bancor, Uniswap v1, Synthetix, Compound, REN, Kyber and 0x. The breakthrough period of 2020 saw a transformative phase, often referred to as the ‘summer of DeFi’, marked by an increase in the popularity of DeFi and included emergence of prominent projects such as Compound, Yearn Finance, SushiSwap and Uniswap v2. Notably, even when DeFi reached its peak capitalization towards the end of 2021, the size of the DeFi ecosystem remained relatively small compared to that of the crypto asset market, constituting less than 10 per cent of the crypto assets market. This disparity becomes even more pronounced when compared with traditional finance (TradFi).1 Market research indicates that the revenue from the DeFi market was approximately US$11.96 billion in 2021, and it is projected to surge to about US$232.20 billion by 2030. This represents a remarkable compound annual growth rate of approximately 42.6 per cent between 2022 and 2030.2 Such growth is a factor that brings DeFi to the attention of regulatory authorities and policymakers. The authorities are not only striving to comprehend this phenomenon but are also exploring ways to establish regulatory access and control and formulate regulatory responses.