Cryptocurrencies and DeFi: Insights from BIS Working Papers
The Bank for International Settlements (BIS) held its 21st Annual Conference in Basel, Switzerland on June 24, 2022, drawing a prestigious group of central bank Governors, academics, and former public officials to discuss the theme of "Central banking after the pandemic: challenges ahead." The conference proceedings, including papers presented at the event, have been published as BIS Working Papers.
Financial intermediaries have played a crucial role in the financial system, serving as the primary nodes for controlling the accuracy of customer accounts, performing bookkeeping functions, and ensuring that only authorized individuals have access to accounts. These intermediaries have served as a necessary link between different parties involved in financial transactions, helping to facilitate the flow of money and information.
However, with the emergence of decentralized finance (DeFi), a new form of intermediation aims to disrupt the traditional financial system by eliminating the need for intermediaries and reducing transaction costs. At the core of DeFi are innovative protocols that operate on blockchains, which are decentralized, permissionless distributed ledgers that keep transaction information in blocks.
This paper examines the various ways in which decentralized finance (DeFi) protocols, which are based on blockchain technology, ensure the security of transactions.
In addition to providing an overview of the cryptocurrency market, and the economic incentives behind DeFi protocols, the paper discusses various DeFi applications, including decentralized exchanges, lending and borrowing platforms, and yield farming. It also compares DeFi with traditional finance, examining how they address issues such as data privacy, transparency, rent extraction, transaction costs, governance, and systemic risk.
Although decentralized finance (DeFi) has the potential to disrupt traditional financial systems, it is not immune to the economic forces that allow intermediaries to hold sway in the market.
The design of decentralized finance (DeFi) applications presents several challenges for tax authorities, as well as increasing the risk of money laundering and other financial wrongdoing. These factors can have negative consequences on the wider economy. As the relationship between DeFi and traditional finance grows, DeFi may also pose a risk to the financial market.
In summary, the paper discusses the potential advantages and drawbacks of cryptocurrencies and decentralized finance compared to traditional financial intermediation. While this new technology holds promise for improving transparency, efficiency, and security in financial transactions, it is important to also consider the risks and limitations.
CBW - External Analyst