On March 24, the International Organisation of Securities Commissions (‘IOSCO’) issued a comprehensive Report setting out how decentralised finance (“DeFi”) ‘is quickly evolving to mirror conventional financial markets’.
DeFi is defined in the Report as ’the provision of financial products, services, arrangements and activities that use distributed ledger technology (“DLT”) in an effort to disintermediate and decentralize legacy ecosystems by eliminating the need for some traditional financial intermediaries and centralized institutions’.
The Report outlines the various products and services used in DeFi, most of them similar to traditional financial products and services and emphasizes the fact that DeFi has enabled the creation of new products and services such as flash loans.
It also outlines the fact that DeFi is subject to lesser regulation and thus poses important risks to investors and the financial market as a whole.
Some of the risks associated with DeFi includes:
Asymmetry and fraud risks related, amongst others, to the lack of important disclosure or misleading disclosure toward retail investors and the fact that DeFi can facilitate a swift, anonymous and often untraceable exit.
Market integrity risks caused by trading and price misinformation or manipulation and conflicts of interest.
Front running for example for transactions using the ethereum blockchain that have proven to be slow enabling frauder to pay a fee to have their transactions processed first .
Nascent stage of development causes risks to retail users due to the lack of comprehensibility, scalability, supportability and reliability of DeFi’s products and services.
Illicit activity risks due to the lack of requirements regarding AML/CFT measures.
Technology and operational risks related to blockchain technology and smart contracts exposed to systems failure or human error.
Cybersecurity risks ‘due to the nascent and permissionless nature of DeFi’.
Governance risks that include the concerns posed by the control of administrative keys and the functioning of protocol governance structures.
To note that IOSCO and its Fintech Network had created the DeFi Working Group (that includes the OSC, IIROC & BCSC) to foster an understanding of the DeFi markets, its typologies and policy implications.