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World Economic Forum and University of Pennsylvania explain the advantages and challenges of DeFi in a joint report

Cryptocurrency

WEF and Wharton School of the United States Release DeFi Report

The blockchain project at the prestigious University of Pennsylvania at Wharton and the World Economic Forum (WEF) have released a report on DeFi (decentralized finance). In the report, he explained the general mechanism and related services related to DeFi, and suggested that a DeFi toolkit will be released for policy makers.

The report was published by the “Wharton Blockchain and Digital Asset Project” at the University of Pennsylvania at Wharton, one of the Ivy League Universities in the United States. Wharton is one of the leading business schools in the United States, and the project analyzed distributed ledger technology (DLT) from a business and regulatory perspective.

The World Economic Forum (WEF), an international organization, is also collaborating in issuing reports, suggesting that the “Decentralized Finance Policy-Maker Toolkit” will be released to policy makers in the near future. In the past, it has announced a toolkit for similar policy makers for the Central Bank Digital Currency (CBDC).

At the Davos meeting held in January, crypto assets (virtual currency) and blockchain technology were also raised as agenda items.

What is DeFi

In the report, DeFi is a general term that includes decentralized, permissionless services and business relationships such as stable coins, exchanges, and lending. Like blockchain, it has supporters and critics, and while it has advantages such as financial inclusion and improved transparency, it is still in the early stages, so risks and returns are mixed, so industry and government officials are fully informed. He called for a nuanced understanding.

The report explains that DeFi is a financial service that can be programmed in an open and trustless manner, using blockchain technology and smart contracts, in a way that does not require an intermediary. In addition, most have some incentive design to maintain liquidity and robustness on the platform.

He also evaluated DeFi as having the potential to improve efficiency in the existing financial system, which has been of growing concern since the 2008 financial crisis. Even in January 2009, during the short squeeze turmoil of GameStop on the investment app “Robinhood”, temporary investors’ transactions were restricted, and there is a possibility of compensating for the vulnerability of the financial infrastructure so far.

However, while enabling the benefits of improving financial market efficiency, transparency, and financial inclusion, there are still many challenges such as repeated fraudulent methods and attacks, and the opportunities, risks, and challenges that regulators pose with DeFi. He emphasized that it is important to have a deep understanding of.

DeFi service type

Although the generic term DeFi includes various services, the following are taken as typical examples.

  • Stable coin
  • Exchange
  • Credit (lending, etc.)
  • Derivatives
  • insurance
  • asset Management

Stable coin

He explained that stable coins are often used in DeFi services. He said that it is useful as a digital asset that is not affected by the liquidity of virtual currencies, and explained that it can be divided into the following three types.

  1. Custodian type
  2. Asset-backed type
  3. Algorithm type

Custodian-type stable coins are centralized stable coins that reserve legal tender and highly liquid assets, such as USDC and Diem on Facebook. Strictly speaking, it does not have a decentralized nature because it requires custodian reliability, but it is often used in DeFi services.

The asset-backed type is a method that uses smart contracts to convert liquid collateral into virtual currency. Algorithm-type stable coins are stable coins that try to maintain a constant value by increasing or decreasing the amount of token supply according to price fluctuations.The latter two types do not require custody, are decentralized, and have a minimum trust. Stablecoin itself is a DeFi service because it only requires it.

Exchange

DeFi can also provide exchanges. Centralized exchanges such as the traditional stock exchange Nasdaq and Coinbase can offer cryptocurrency trading utilized in the DeFi domain, but such exchanges are custody. Explained that it is not programmed.

In contrast, the decentralized exchange (DEX) can leverage smart contracts, AMMs (automatic market makers), and lock up cryptocurrencies to receive yields. The locked-up virtual currency is used to guarantee the liquidity of exchanges and to guarantee security.

However, the report explains that DEX still has many issues such as security, reaction time, scalability, and fees.

credit

He introduced that there are other credit services such as lending and borrowing as typical examples of DeFi services. In general, by collateralizing virtual currency, assets can be received and loans can be secured on smart contracts, so procedures such as valuation required for conventional loans can be omitted.

Derivatives

In addition, the report reports that traditional finance requires a third-party intermediary such as the Japan Securities Depository Center, Inc., but the DeFi platform makes it easy to open up new markets based on the prices of stocks, commodities, and virtual currencies. Explain that it can be done.

Not limited to derivatives, DeFi explained that it is characteristic that sellers and buyers can be directly connected with the incentive pool as collateral.

In addition, the report introduces functions such as insurance that provides asset guarantees and asset management that deposits virtual currency in pools in the unlikely event of an asset outflow on the DeFi platform. He said that the business form of the DeFi protocol is still developing, as various other services are emerging one after another.

He said that regulators, individual investors, traders, and institutional investors need a nuanced understanding in the new area of ​​DeFi, where both expectations and challenges exist. DeFi is still evolving, with developers aiming to fix vulnerabilities every day and introducing new mechanisms. Ultimately, he considered that maintaining high reliability would be the key even on an open financial platform.

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