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OECD Report: Why DeFi Matters and Policy Implications

McCarthy Tetrault | Ana Badour, Nancy J. Carroll ,Hartley Lefton, and Marc-Antoine Addoumie | Feb 10, 2022

why defi matters and policy implications - OECD Report:  Why DeFi Matters and Policy ImplicationsOn January 19, 2022, the Organisation for Economic Co-operation and Development (the “OECD”), an intergovernmental organization founded to stimulate economic progress and world trade, published “Why Decentralised Finance (Defi) Matters and the Policy Implications” (the “Report”), a report on the growing application of decentralised finance (“DeFi”), and its increasing interconnectedness with traditional financial markets. The Report outlines some potential benefits of DeFi and describes why, in the OECD’s view, DeFi presents an “urgent challenge for policy makers”.

Evolution and Current State of DeFi

The Report defines DeFi as a development in the crypto-asset space seeking to replicate the traditional financial system in an “open, decentralised, permissionless and autonomous way” based on the use of blockchains, typically built on the Ethereum blockchain network. The key defining features of DeFi projects include:

  • “non-custodial nature”, which implies the absence of a central authority accessing or controlling participants’ digital assets;
  • “community-driven governance”, whereby markets rely on participants for decision-making; and
  • “composability”, through which components of DeFi can be pieced together to create new products.

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The Report observes that collateralised lending, which accounts for more than half of the value of crypto-assets locked in DeFi applications, is the fastest growing DeFi product. The Report finds that DeFi lending activities try to mirror market-based lending, such as securities lending and repurchase agreements, rather than traditional retail bank lending. While most DeFi market activity involves collateralised lending, the Report notes that uncollateralised lending is possible in DeFi through flash loans, through which borrowers make and repay a loan in the same single transaction.

A significant driver of lending activity in the DeFi space is yield farming, by which users lock their crypto-assets in a lending protocol (i.e. the system that enables lending and borrowing through smart contracts) to provide applications with liquidity in exchange for crypto rewards in the form of transaction fees. The Report identifies this as a key difference of DeFi as compared with traditional lending activity, as it allows the borrowing of assets leveraged by other DeFi users.

Other prominent DeFi applications identified by the Report include decentralised exchanges (DEX), derivatives and synthetics, asset management, insurance, payments and prediction markets.

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