Posted by Team Blockchain on 18 June 2021
Tagged to Blockchain, Derivatives, OTC

This content has been created by Team Blockchain, an independent platform providing insight and expertise on Blockchain, Tokenomics and the Crypto market.

The value of capital that is committed to the DeFi market reached over USD140 billion in mid-May and currently stands at over USD100 billion. DeFi is defined as: “Decentralized finance is a blockchain-based form of finance that does not rely on central financial intermediaries such as brokerages, exchanges, or banks to offer traditional financial instruments, and instead utilizes smart contracts on blockchains.”

Other definitions come from Ethereum, which include:

  • a global, open alternative to the current financial system
  • products that let you borrow, save, invest, trade, and more
  • based on open-source technology that anyone can program with.

Interestingly, one of the biggest asset classes globally is derivatives, with some estimating the market to be over USD1 quadrillion in size. According to the Bank of International Settlement, the Over The Counter (OTC) derivatives market alone was USD15 trillion in the first half of 2020. OTC trading is essentially peer to peer, not dissimilar to what DeFi offers; that is, trading without intermediaries. However, the Commodity Futures Trading Commission Commissioner (CFTC), Dan Berkovitz, has recently said: “A system without intermediaries is a Hobbesian marketplace with each person looking out for themselves. Caveat emptor –‘let the buyer beware’. Not only do I think that unlicensed DeFi markets for derivative instruments are a bad idea, I also do not see how they are legal. Apart from the legality issue, in my view it is untenable to allow an unregulated, unlicensed derivatives market to compete, side-by-side, with a fully regulated and licensed derivatives market”

The challenge posed is, as we see more decentralised DeFi platforms emerge, how can regulators such as the CFCT sanction, control, or even influence these platforms? If institutions wish to use them because they are more efficient than the current ways of trading, could we see considerable volume (certainly of OTC trading) migrating to DeFi platforms? Back in February 2021, Bitwise launched the DeFi Crypto Index Fund as a way to gain exposure to the DeFi sector. Interestingly, concurrent to this, the World Economic Forum (WEF) has issued a ‘DeFi Policy Maker Tool Kit’ offering guidance to regulators about DeFi. Whilst not making specific recommendations, it aims to describe the issues DeFi may address, as well as highlighting areas on which some regulators may need to refresh their memories! As we witness organisations such as the WEF engaging with DeFi, it will no doubt gather more institutional and regulatory attention, potentially leading to greater adoption of this sector by institutional investors.

The authors

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