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Bank of England peers into the opaque world of DeFi

Bank of England peers into the opaque world of DeFi

The Bank of England has begun to explore how to manage risks generated by the rapid initial growth of decentralised finance, or ‘DeFi’ applications.

DeFI refers to decentralised, algorithm-based financial services that rely on smart contracts and are delivered over DLT platforms without intermediaries.

The most prominent use for DeFi at present is the provision of credit. Lending currently represents nearly half of the DeFi market.

However, the DeFi model and technology can be deployed to replicate a range of financial services such as savings, trading, insurance and derivatives. DeFi is very small at present but growing very fast, from less than $10bn at the start of 2020 to nearly $100bn last month.

Bank of England deputy governor for financial stability Jon Cunliffe says that the highly decentralised and global structure of the DeFi sector along with the difficulty to trace end users provide a unique set of challenges for regulators.

"Even on an initial view it is clear that the sector is opaque, complex and undertakes financial activities that carry risk - activities that are regulated with the traditional financial sector," he says. "There are pronounced market integrity challenges given the absence of investor protection, AML and other market integrity provisions."

He points out that even were such provisions in place, there may be no one for regulators to engage and hold accountable.

"In an extreme form, a DeFi platform could be completely decentralised with no identifiable legal entity, ownership nor even a point of human contact," states Cunliffe. "DeFi is still in its early infancy but its rapid growth means that regulators, domestically and internationally, need to think seriously now about the risks of a broad range of financial services being effected through DeFi platforms and how to ensure risks are managed in the DeFi world to the same standards as they are managed in traditional finance. At the Bank of England we have begun work to this effect."

Cunliffe made his remarks in a speech to the virtual Sibos conference, where he also called for urgent regulatory intervention to protect the financial system from any crashes in the cryptocurrency markets.

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