EU Regulator Drops The Bomb On DeFi

It has been just revealed that an important EU regulator has just warned of important DeFi risks. Check out the latest reports about this below.

The European Securities and Markets Authority has released a report that outlines several risks to investors and financial stability that arise from decentralized finance.

Despite DeFi’s overall small exposure to investors, the report warns that there are serious risks to investor protection due to the highly speculative nature of many DeFi arrangements, significant operational and security vulnerabilities, and the absence of a clearly identified responsible party.

The independent EU authority cautioned that DeFi operates without trusted intermediaries, which could otherwise help mitigate risks related to financial stability and investor protection.

The report, which was published on Wednesday, highlighted the regulator’s primary concerns regarding DeFi innovations. It classified smart contracts into five categories to assist regulators in comprehending the “enormous technological complexity of these systems.”

The report highlights concerns about the “code is law” ethos that dominates current DeFi governance.

The regulator stated that smart contracts still lack regulation and follow the principle that “code is law”, which leads to a tendency to accept smart contract outcomes without considering any moral or legal implications.

The study acknowledges that DeFi’s automated and immutable functions pose less risk to counterparties defaulting compared to traditional settlement.

However, it emphasizes that developer anonymity can result in a proliferation of illicit smart contracts.

According to the paper, the anonymity of smart contract developers and their lack of accountability have led to the rise of “illicit” smart contracts, such as Ponzi schemes.

The regulator said the composability of smart contracts could amplify system faults and lead to increased contagion risk, as noted by The Block. 

“The composability feature of smart contracts, which allows for DeFi protocols to build on top of each other, enabling a variety of services for users, also creates dependencies among protocols, leading to a risk of contagion,” the paper added. “The default of one actor can quickly propagate through the system.”