There are more than 1,400 DApps in operation and their number is growing rapidly, according to a US Federal Reserve Board discussion paper dated June but published on August 30. Ethereum is its largest host with 470, or 31% of them. ANDThese decentralized finance (DeFi) products represent a very small part of the global financial system, but can still pose risks to financial stabilityaccording to the authors.
The cumulative gross value of DeFi products ranged from $78 billion to $224 billion at the start of Q2 2022, depending on how DeFi was defined, according to the document. Those numbers have fallen dramatically since then, as crypto winter descended. At the same time, technological advances are improving the processing power of DeFi. The authors speculate that wholesale investors are the biggest users of DeFi.
Most of the document was devoted to the risks and benefits that the authors perceive in DeFi. Cryptocurrency volatility inhibits the growth of DeFi, and the risks to the broader financial system are small at present, according to the authors, but:
“The ability to build large leveraged positions and to hide trades to some extent, combined with the novelty of financial products that allow for such leverage, have been common elements in the history of financial crises in the last century.”
Many of the reflections in the document display a similar cynicism.
DeFi’s resistance to censorship is overblown, and transparency could be a competitive disadvantage for institutional investors and an invitation to commit illicit acts, according to the authors. Retail investors will always be vulnerable, as:
“If cryptocurrencies are going to become a mainstream product, then they are going to be widely used by people who lack the ability to properly assess the programming and economic risks associated with their cryptocurrency transactions.”
Finally, the potential further integration of DeFi with traditional finance exposes the traditional side to risk because, “if a user suffers losses transacting through a dapp, the user might have a hard time determining who to sue on the DeFi sidebut it might not be difficult to identify traditional intermediaries who might have some legal liability.”
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