In a new working paper, The Bank for International Settlements discusses decentralized finance (DeFi) and introduces the DeFi Stack Reference (DSR) model to illustrate the functionality and risks of the technology. The report discusses the integration of DeFi with traditional finance and suggests ways to assess your risks during that integration.
The paper examined the architecture, technical primitives, and functionalities of the DeFi protocols in considerable technical detail. “In many circles there is still a lack of deep knowledge about DeFi,” the authors write, “which calls for a specific framework to improve practical knowledge of the technology.”
The effort is worth it, according to the document, for the innovation of DeFi:
“It is not yet clear if and to what extent DeFi will proliferate in the future. […] Nevertheless, we consider DeFi to be a significant development because it takes advantage of innovative technology that could shape the future financial ecosystem.”
Algorithmic automation, “competitive financial engineering” and transparency “are of interest well beyond cryptocurrency markets,” the document states. By competitive engineering, the authors understand compossibility, that is, the combination of smart contracts to form complex and unique financial products.
The DSR model divides DeFi into three layers: interface, application, and settlement, with sublayers allowing for observed variation between DeFi technologies. In its examples, the paper uses a variety of tokens, blockchain networks, and financial services. The run on Terra (LUNA) was discussed in detail for its informational value and as an example of the effectiveness of the authors’ investigative technique.
This working paper appeared the same week as the World Economic Forum (WEF) published an overview of Decentralized Autonomous Organizations (DAOs). Both works are very complementary, since the FEM publication was equally exhaustive but not technical.
#DeFi is a programmable financial ecosystem that lets users trade, lend and invest without relying on a central intermediary. This paper deep dives into the underlying technology, its economic potential and the related risks https://t.co/NLkvja6Not #Ethereum #blockchain #DLT pic.twitter.com/EnccGmmf93
— Bank for International Settlements (@BIS_org) January 19, 2023
The BIS regularly participates in research on digital currencies issued by central banks. He has taken a very cautious stance on cryptocurrencies. It recently imposed a 2% cap on crypto assets in international bank reserves, effective January 1, 2025.
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