Decentralized Finance (DeFi) 2022

Decentralised finance, or DeFi for short, encompasses a wide range of applications based on blockchain infrastructures, which facilitate financial market applications such as trading or credit transactions. One thing DeFi projects have in common is that they use open-access blockchain infrastructures such as Ethereum or Solana to handle financial transactions largely automatically and without the involvement of traditional financial intermediaries. For example, payment or asset tokens can be traded in this way without the involvement of a supervised trading venue. Often, assets need to be deposited as collateral for the use of DeFi applications. Their use is normally open to anyone.

DeFi applications have attracted much attention in recent years. The initiators of such projects take the view that DeFi can structurally and fundamentally change the financial market. Despite the case for decentralisation, however, many DeFi projects are currently often run, materially influenced or controlled by just a few people or companies, which raises questions about adequate supervision. A further problem is the lack of transparency surrounding many projects due to the very limited publicly available information. FINMA assesses DeFi projects based on their economic substance rather than their legal form and applies existing law in accordance with the principle of “same business, same risks, same rules”.

Should the vision of penetrating the financial markets with DeFi applications be realised, new challenges would emerge for regulators and supervisory authorities:

  • Responsibility could no longer be clearly assigned under current financial market law.
  • Existing regulatory concepts could be rendered ineffective due to a lack of identifiable intermediaries. Because DeFi projects would also often have no identifiable presence or substance in a particular country, this would raise questions about territorial jurisdiction.

Use of DeFi applications

The use of DeFi applications presents risks. Regarding the exposure to risk, a distinction must be drawn between the use of DeFi by consumers and by institutions.
If consumers use DeFi applications, in the first instance they risk losing assets, for example due to severe market fluctuations, input errors, bugs in the DeFi applications, hacking or fraud.

For institutional users, the risks are primarily operational as well as legal and reputational in nature. According to an analysis published by the FSB in February 2022, there are at present no systemic risks as the volume is still small. However, if they were to be used on a wide scale, the inherent instability of DeFi ecosystems could spill over into the traditional financial markets and threaten their stability. The risk of money laundering is generally high due to the anonymity of most DeFi applications.

FINMA is closely monitoring the trend towards increased development and use of DeFi applications. This is especially true where FINMA-supervised institutions use or intend to use DeFi applications. It applies the proven principles of “substance over form” and “same risks, same rules” to such matters and always makes its decisions based on the actual economic circumstances.

(From the Risk monitor 2022)

FINMA Risk Monitor 2022

Updated: 10.11.2022 Size: 0.52  MB
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