- Decentralized Finance is a collective term for commodities offered on the blockchain
- Regulating DeFi is tough
What is Decentralized Finance (DeFi), and how does it work?
Decentralized Finance is a collective term for commodities offered in digital platforms without financial intermediaries in crypto markets. The absence of involvement of central financial intermediaries means that the digital platform is available for everyone and does not involve financial statements from institutions and blockchain.
With smart contracts instead of traditional financial statements, investors are at an advantage of borrowing, lending, and earning interest on digital assets invested using DeFi. Defi enables anybody to trade and invest in digital assets as long as one is connected to the internet.
Considering that the system is decentralized, regulating it is hard. Around $60b is locked in Decentralized Finance; hence, it is necessary to control the activities happening in the platform for the security of investors and their assets. However, unlike traditional forms of investment where the Finance is centralized, no statements are offered to prove the transaction. This is because the digital platforms do not fit the pract5icallity of traditional financial transactions.
Challenges faced when regulating DeFi
Classifying digital assets
Digital assets are available in different types and forms. They are the items traded in digital markets. Unlike fiat currency that deals with primarily tangible goods and services, digital assets are sold on digital platforms. Regulation of the same is paralyzed as they come in different forms.
Source of information
The digital world works indiscretion unlike traditional trading methods with intermediaries who keep records of transactions and activities. Most investors are reluctant about availing information about their dealings, mainly for security reasons. Information about a crypto coin and the transaction it undergoes remains with the user.
It works on a decentralized network
One thing that makes digital assets very unique is that it is not bound to geographical borders. The decentralized system works globally. Because different financial institutions operate on different legal regimes, DeFi cripples regulation as it is subject to none of those. In a centralized network, there is a regulated financial system which is not so with DeFi.
Anonymity in cryptocurrency trading may lead to fraud and theft. Anonymous investors in DeFi work both as an advantage and disadvantage. As traders wish to remain discrete with their transactions, opportunists grab this opportunity to participate in criminal activities as tracking them is complex, and there is no regulatory board on the same yet.
Use of smart contracts
As smart contracts are run and functioned by codes and algorithms, it is difficult to tell what is entailed in one. They are unique and automated to suit the terms of the buyer and seller of digital assets. Since they are encoded, regulating them will be hard. They ensure the smooth running of activities with AI controlling the terms and regulations governing each of them.
It is easier for regulatory bodies to govern activities with an intermediary so that every action is recorded. This is not so with DeFi. As much as they try to develop a standard regulatory body, it will be hard since the cryptocurrency field is diverse.