1. DeFi mimics traditional finance (TradFi) functions but introduces new risks
DeFi aims to provide financial services such as payments, lending, and asset management without intermediaries. However, its design—based on anonymity and automation—exposes users to new forms of market failures, including information asymmetry and systemic vulnerabilities.
2. Smart contracts and composability: innovation and fragility
Smart contracts enable automated financial activity on-chain, and composability allows protocols to build on one another. But these features also create interdependencies that can amplify shocks across the DeFi ecosystem.
3. Stablecoins: essential but unstable
Stablecoins are central to crypto transactions. While fiat-backed stablecoins dominate the market, they are sensitive to crypto market stress and monetary policy shifts. Algorithmic stablecoins, such as TerraUSD, have proven especially fragile.
4. Regulatory implications: ban, contain, or regulate
The authors assess three strategic responses to crypto risks:
- Ban: Considered infeasible and undesirable due to global mobility and innovation potential.
- Contain: Ensure that TradFi and the real economy are insulated from crypto spillovers.
- Regulate: Tailor regulation based on economic functions and embed compliance rules in smart contracts.
5. Cryptoisation risk in emerging markets
In economies with weak currencies or inflationary pressures, cryptocurrencies may replace local currencies, threatening monetary sovereignty. Regulators may need to impose controls or incentives to limit this trend.
6. Investor protection and market safeguards
As DeFi reaches a critical mass of users and capital, safeguarding participants becomes urgent. Recommendations include enhancing disclosure, enforcing standards on smart contracts and developer accountability, and regulating key actors like stablecoin issuers.