How should DeFi be regulated? A European approach to decentralization
Decentralized finance, known as DeFi, is a new use of blockchain technology that is growing rapidly, with over $237 billion in value locked up in DeFi projects as of January 2022. Regulators are aware of this phenomenon and are beginning to act to regulate it. In this article, we briefly review the fundamentals and risks of DeFi before presenting the regulatory context.
DeFi is a set of alternative financial systems based on the blockchain that allows for more advanced financial operations than the simple transfer of value, such as currency exchange, lending or borrowing, in a decentralized manner, i.e., directly between peers, without going through a financial intermediary (a centralized exchange, for example).
Schematically, a protocol called a DApp (for decentralized application), such as Uniswap or Aave, is developed in open source code on a public blockchain such as Ethereum. This protocol is powered by smart contracts, i.e., contracts that are executed automatically when certain conditions are met. For example, on the Uniswap DApp, it is possible to exchange money between two cryptocurrencies in the Ethereum ecosystem, thanks to the smart contracts designed to perform this operation automatically.
Users are incentivized to bring in liquidity, as they receive a portion of the transaction fee. As for lending and borrowing, smart contracts allow those who want to lend their funds to make them available to borrowers and borrowers to directly borrow the money made available by guaranteeing the loan with collateral (or not). The exchange and interest rates are determined by supply and demand and arbitrated between the DApps.
The great particularity of DeFi protocols is that there is no centralized institution in charge of
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