Defi's promise to democratize finances remains a distant reality

The author is a professor at Cornell University, Senior Fellow at the Brookings Institution and author of " The future of money

A cryptocurrency winter has used, with the prices of many cryptocurrencies and the total value of such digital assets falling over half of their maximum values ​​of six months ago. The idea of ​​the idea is that crypto-assets are immune to changes in the macroeconomic fundamental data and serve as protection against inflation.

The chaos has thrown a bright light on the decentralized blockchain-based financing, as weaknesses focus on their basic principles. With all the promises to democratize finances and expanding access to financial resources, the emerging reality indicates a concentration of economic power, while the risks are largely supported by investors who are least able to deal with it.

But the crypto adjustment could help the long-term livelihood of blockchain-based financing by dampening unrestrained speculations and at the same time causing the regulatory authorities to act quickly.

The decentralized financing, or defi, is based on three principles. It has decentralized architectures, whereby public digital main books are on several computers and synchronized in real time. Decentralized trust includes the validation of transactions by public consensus mechanisms and not through trustworthy agents. Finally, and that is crucial, the decentralized governance is underpinned by a collective interest in the maintenance and safety of the system. Bitcoin is a good (albeit primitive) example of defi.

These principles prove to be incompatible with functionality. Cryptocurrencies that work well as a medium of exchange are indeed centralized. Stablecoins are usually secured by reserves of Fiat currencies, which are issued by a private party that validates transactions and leads centralized accounts, and with operating rules defined by the issuer. Meanwhile, algorithmic stable coins, which are said to be supported by other cryptocurrencies, but are still managed by their issuers, have been stalling strongly in recent weeks.

decentralization proves to be illusory even at crypto-assets like Bitcoin. A handful of computer consortia now dominates the process of validating Bitcoin transactions, and ownership is also concentrated. The design of some systems that are more efficient than the inefficient "Proof of Work" consensus protocol from Bitcoin leads to a concentration of governance.

"Proof of Stake", an alternative consensus mechanism in which users have to pledge a "stake" of digital currency, enables faster decentralized validation of a much larger transaction volume than proof of work. But this system is also susceptible to the takeover by a small group that acquires a large proportion. Although it is not in the interest of the group to endanger the integrity of the system, they could move the rules to their advantage.

cryptocurrencies and defi are useful among authoritarian regimens and in companies in which the government machinery collapsed. For countries such as El Salvador and the Central African Republic, the introduction of Bitcoin as a legal means of payment offers a better alternative than any local currency.

But Defi's promise to create new financial products and services, expand access and to undercut traditional financial intermediaries remains a Fata Morgana. Existing institutions coopate the new technologies. Approved blockchains, which are controlled by a small group of institutions, contribute to improving traditional finances, but in turn could concentrate power on a few institutions and restrict competition.

Most of Defi contains completely or even overpassed financial instruments. This helps to maintain trust and financial stability, but is hardly beneficial to expand access. After all, the lack of collateral is a major obstacle for middle -class households and small business owners who are looking for access to loans and other financial products. In addition, the lack of financial knowledge and investor protection has indefinitely added (or ignored) the risks and invested heavily in crypto systems.

The regulatory authorities must act quickly to avert the risks associated with decentralization and at the same time limit an unintentional concentration of power. You also have to include DEFI products and services that have escaped the supervision due to your technological novelty. The idea that the self -interest of the community leads to self -correlating mechanisms that limit the risks and the claim that these products are naturally safe and protected are not durable.

A well -thought -out regulatory supervision could be exactly the right means of lending this sector stability, preventing existing inequalities and enabling us to use the advantages of these new technologies and at the same time limit the risks.