IMF’s DeFi Governance Recommendations Include These Two Steps

The International Monetary Fund (IMF) has proposed a series of measures aimed at regulating the decentralized finance (DeFi) sector.

The body spelled out its preliminary recommendations in the latest chapter of its Global Financial Stability report, which is entitled “The Rapid Growth of Fintech: Vulnerabilities and Challenges for Financial Stability.”

In the document, the report’s authors recommended that “as a first step,” regulation should focus on “some elements of the crypto ecosystem that have enabled the development of DeFi” – namely stablecoin issuers, centralized crypto exchanges, and hosted wallet service providers.

However, the IMF also claimed that this kind of proposed regulation could also extend to reserve managers, network administrators, and market makers – all of whom would, the body wrote, “benefit from robust and comprehensive national regulatory frameworks delivered through common global standards by standard-setting bodies.”

The authors suggested that such “centralized entities” in the “cryptoasset ecosystem” could provide regulators with “an effective liaison for regulators to address the risk of rapid DeFi growth.”

But the authors also outlined a “second step” in regulatory policy that would involve national authorities “directly” regulating what they called “key functions within DeFi.”

Such “measures,” the authors explained “could include” a “public-private collaboration on code regulation” through “either ex-ante guidelines on operational and risk parameters or ex-post code reviews and audits that can identify areas vulnerable to risk and help deliver policy objectives.”

The body suggested promoting transparency and boosting “user education to help identify platform-specific risks,” which it claimed would close the “information gap between retail and institutional investors.”

As well as developing industry codes, the body suggested that the DeFi sector “establish self-regulatory organizations,” claiming that a “transparent and credible governance system could improve risk management, facilitate good conduct of financial transactions, and eventually attract more users and capital to the platforms.”

But more importantly for regulators, the IMF claimed that this governance system model “could be a natural entry point for regulators to interact” with.

And, perhaps with half an eye on the Japanese centralized crypto exchange sector, which is largely self-regulated, the IMF suggested that “much as in traditional securities markets, self-regulatory organizations for centralized crypto exchanges would lead to more robust listing standards for (tokens of) DeFi platforms and thereby improve their governance and quality.”

The authors conceded that regulation would likely prove tricky in the field of DeFi – as even policing the centralized crypto field has proven “challenging” thus far. And while a more heavy-handed approach was not ruled out, the authors admitted that this would likely have undesirable ripple effects, explaining:

“One potential approach is to restrict the exposure of regulated firms to DeFi markets (especially markets not subject to proper regulation or self-regulation), which could slow the pace of growth while addressing the risks of interconnectedness with regulated markets.”

However, the focus was not entirely on mitigating risk and regulation, with benefits of adoption also discussed. The IMF report authors also noted that DeFi “has the potential to exhibit cost-efficient financial intermediation by bypassing and short-cutting the intermediation chain.”

But, the authors warned, “comparing costs and prices between DeFi and traditional financial institutions” is a “complex” matter, due to the fact that “the two currently operate in different ecosystems.”

While the IMF warned of “greater risks and uncertainties” from DeFi, it conceded that the sector “has the potential to offer financial services with even greater efficiency, becoming a gravitational force that attracts a large number of crypto investors.”
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