A new research report presents the outcome of a detailed study undertaken by IBM Promontory for the European Commission on embedding supervision in the decentralized finance (DeFi) ecosystem.
The project comprised four different phases: identifying use cases and protocols to assess, defining elements of comparison (benchmarks) to supervision in traditional finance (TradFi), developing a software application to collect data from the ledger, and analyzing the collected data to assess the potential of embedded supervision.
After analyzing four different use cases and eight protocols, the report concluded that ledger technologies offer real-time access to core transaction information.
IBM Promontory also identified that there is data available for supervision of DeFi activity which would allow development of tools supporting regulatory objectives. But it would probably be a bad idea or approach to try and regulate DeFi with the same set of rules governing TradFi. The global regulatory framework needs to be updated before it can be applied to emerging areas of finance including DeFi.
However, available data is fairly limited compared to today’s data on traditional financial markets, banking and insurance activities, due to the difference of maturity between TradFi and DeFi. Of course, this is quite understandable given that DeFi is a very new and emerging area of modern finance.
Considerable challenges were reportedly encountered when assessing the potential of embedded supervision in the DeFi ecosystem, such as the lack of standards, the need for expertise across DeFi and TradFi, as well as the pseudonymization of wallets.
Although it seems DeFi lacks standards, we might be trying to, or expecting to, create the equivalent of such standards found in the TradFi space. However, the evolution of DeFi is fundamentally different from traditional finance due to heavy emphasis on decentralization and open-source. When DeFi matures in the coming years, we might finally realize how the infrastructure supporting web3 and open finance is actually a lot different than what we had been used to before.
A risk-based approach targeting the largest protocols and liquidity pools and the collection of reference data are vital in overcoming these obstacles, according to the comprehensive research report.