What is fueling the rise of Decentralized Finance? What is the role of Governance Tokens, DEXs, DAOs and Yield Farming in this rise? How is this industry regulated and what should policymakers consider in moving forward?
INATBA’s recent roundtable series “DeFi vs Regulations: The Future of Finance” set out to answer these questions. Consisting of three sessions held weekly throughout February, the goals of the event were clear: investigate the intricacies of this growing industry in an educational and thought-provoking manner.
The series kicked off on the 9th of February with a presentation by Donna Redel, key organizer of this event and INATBA Academic Advisory Body Member. She provided a brief introduction to Decentralized Finance, commonly known as DeFi, compared to centralized, traditional finance, otherwise known as CeFi.
Donna’s presentation was followed by a first-panel discussion on the general topic of DeFi, showcasing important projects in the industry. The panel was moderated by Rebecca Rettig, a US-based attorney from Manatt, Phelps and Phillips with extensive expertise on blockchain and crypto-asset firms. Rebecca was joined by Founders Stani Kulechov of Aave, Mona El Isa of Enzyme Finance and Mel Gelderman of Monolith.
Aave is one of the biggest lending protocols in DeFi and the creator of Flash Loans, instant, free loans that can be requested by users with no collateral as long as they are returned to the platform within the same Ethereum transaction. Enzyme Finance is one of the pioneers in the non-custodial, smart contract-based asset management protocols. Monolith is the most popular bridge between DeFi users and traditional banking services, providing a Debit card associated with DeFi earnings.
The panel opened with a discussion of early stages in DeFi development when Ethereum fees were low enough to allow protocol interoperability for all users without heightened Gas costs. Panelists also touched upon both past and present legal and regulatory barriers for their projects. Capturing the enterprising spirit of the industry, Gelderman noted, “this is arguably the industry with the highest concentration of geniuses in the world, working together on solving problems that will benefit all of us!”
“Thus far, our interactions with policymakers has been nothing but positive. We ask that this continues across other jurisdictions and as regulations grow close to being realized.”
Kulechov and El Isa agreed with this, the latter adding to the discussion on regulations in saying, “thus far, our interactions with policymakers has been nothing but positive. We ask that this continues across other jurisdictions and as regulations grow close to being realized.”
Jori Armbruster, Co-Founder and CEO of EthicHub, followed with a presentation on DeFi for social impact, demonstrating how his company uses its token, Ethix, and other incentives to directly connect coffee farmers in Latin America with buyers through microloans. These microloans are financed by users who earn interest and are protected from defaulting through staked Ethix provided by the company. He remarked, “We’ve been able to offer more than 100k USD in microloans, and we’ve experienced zero defaults – all that thanks to the DeFi-focused processes that are used across the industry.” A community–first approach demonstrated by Armbruster’s EthicHub is a unique application of Decentralized Finance that policymakers may not have interacted with until this event.
The last panel focused on compliance and regulations related to DeFi. Moderated by Ernst and Young’s Magnus Jones, a blockchain and compliance specialist, the panel also featured Jenny Leung of Ketsal Law Firm, Jack Sutton of Gemini Exchange, Pawel Kuskowski of Coinfirm and Florian Glatz of Bundesblock. Panelists focused on how existing laws and regulations have targeted decentralized projects and how compliance could be enforced on Ethereum and other public permissionless blockchains. Finally, they considered what future-proof regulations should include if set in motion today.
“Regulators need to consider completely different tactics when it comes to DeFi! This has not been the case as of yet.”
Glatz added this takeaway: “Regulators need to consider completely different tactics when it comes to DeFi! This has not been the case as of yet.”
Week 2: Decentralized Exchanges and Yield Farming
The second session of this series offered an education-focused discussion on DEXs and Yield Farming. The first panel, moderated by Consensys’ Lex Sokolin, featured leading pioneers in Decentralized Exchange protocols and derivatives creation: Sergej Kunz of 1inch, Hart Lambur of UNA and Michael Egorov of Curve Finance.
Kunz explained that 1inch’s protocol is a DEX aggregator that allows for trades to take place across multiple platforms. 1inch helps users find the best possible path, fee-wise, for such a trade. Lambur followed by introducing UMA protocol and the derivatives that you can create within its platform. Such derivatives, which can currently only be traded in DEXs, are fully backed by only crypto, yet they represent the value and movement of assets outside of crypto like the price of gold or S&P500 index.
After a brief description of DEXs, Sokolin, who leads Consensys’ popular wallet MetaMask, started the conversation by exploring the potential impact of DEXs, with questions related to the viability and design of these exchanges. Lambur noted, “For the first time in history, we are seeing the growth of a truly global financial marketplace, with access for anyone with an internet connection.”
“For the first time in history, we are seeing the growth of a truly global financial marketplace, with access for anyone with an internet connection.”
Egorov added, to achieve a truly global scale, traditional exchange processes cannot work in crypto: “Currently, Decentralized Exchanges are extremely reliant on the invention of Liquidity Pools.” Kunz added, “it doesn’t make sense to trade on only one set of liquidity pools.” Instead, the 1inch protocol provides access to liquidity across multiple platforms.
The fast-moving status of DeFi was captured in Sokolin’s quote, “Everything is being built currently at a very fast pace. We will see CBDCs within DeFi in the future, and that will be a good thing.”
“We will see CBDCs within DeFi in the future, and that will be a good thing.”
The second panel on Yield Farming was moderated by Samsul Karim, Business Development Lead for Binance Smart Chain (BSC). The panel featured ParaSwap’s Mounir Benchemled, Argent’s Itamar Lesuisse and, once again, Curve Finance’s Michael Egorov. The panelists first introduced their projects: ParaSwap is a DEX aggregator, similar to 1inch and other examples, Argent is arguably the most user-friendly wallet and DeFi interface in the industry and Curve is the most used Stablecoin Automated Market Maker and one of the industry’s most successful projects in 2020.
The panelists continued to reach a definition of Yield Farming, explained as the process of providing liquidity into a Liquidity Pool, and, in return, earning a percentage of the transaction fee collected when exchanging two asset stakes in this aforementioned Liquidity Pool. Yield Farming is an active process, where users look to provide liquidity to a DEX or Pool with the greatest amount of possible rewards. As both Lesuisse and Benchemled mentioned, Yield Farming is similar to a point system in a traditional enterprise: the more you use the service, the greater the reward. However, instead of an independent point system, earned rewards give users ownership of the associated protocol.
Yield Farming, and the multiple applications of these techniques in growth and community leadership, are the reason volumes locked in Liquidity Pools have exploded. As Samsul mentioned, “after the money locked in Liquidity Pools fluctuated between 0.5bn and 1bn USD all throughout 2019, the value exploded to more than 40bn locked in these pools.” This is arguably the most interesting feature of the discussion on this technology: Yield Farming works because it currently benefits all parties involved, from protocol creators to early investors and liquidity farmers, as well as customers, who are now able to source liquidity in exchanges that do not act as custodians of the assets.
Week 3: DAOs and Governance Tokens
The final roundtable was held on February 23rd and expanded on Decentralized Autonomous Organizations (DAOs) and Governance Tokens. The first panel was moderated by Priyanka Desai, a DAO and Legal DAO (LAO) expert from OpenLaw who is also active in the NFT space, and featured Patrick Rawson of CurveLabs, Jack du Rose of Colony and Marina Markezic of Unlawcked.
Rawson’s work with Curve Labs is often at the cutting-edge of DAO research. Colony, under the leadership of du Rose, aims to provide the most approachable DAO creation protocol in the world, allowing users to deploy a DAO with little-to-no code. Markezic is of the most recognized experts for DAOs and associated regulations in Europe.
The discussion started by defining DAOs, a consensus that was hard to find among panelists. What started off as “a chain-based organization” quickly shifted to more complex definitions and conversations. “Over time, what we can do in a DAO has expanded. It is more than voting; it is more like a Central Bank, since you have a token and a treasury, and the value of the token is floating and determined by the market, so everything you do matters” said Rawson. Du Rose added to this, stating “I really hope that the perception that a DAO is only about voting shifts in the year to come.”
“Some applications of DAOs might currently be illegal under existing law, but that might soon change and open a number of interesting applications.”
In discussing the current hurdles of running a DAO, both in terms of organizing the community effectively and maintaining compliance, the panelists agreed that private choice research and the implementation of new governance structures would unlock tremendous value through DAOs in the years to come. Markezic remarked, “Some applications of DAOs might currently be illegal under existing law, but that might soon change and open a number of interesting applications.”
The DAO panel was followed by the final segment of this roundtable series: a one-on-one digital fireside chat with Compound Finance’s CEO and Co-founder, Robert Leshner and INATBA AAB Member, Donna Redel.
Leshner first introduced Compound as an automated, on-chain lending platform with around 9bn USD in staked assets that accrue interest as they are lent out. In short, users stake their assets for an interest rate, for example, 7%, and the protocol lends out these funds at a 9% rate, allowing for a 2% income rate for the protocol and its team.
This project was founded in 2017, when skepticism on what could be done through smart contracts was still very high. Leshner explained how the project initially tested these hypotheses and then moved to form a more decentralized governance system. He noted, “We follow the Meteor Rules, which mean that if a meteor fell on earth and wiped out the core development team, we still want our protocol to be perfectly functional.” This means that the team would a) not be necessary for any core changes to the protocols, and b) that the Compound Finance community would be enabled to make all core decisions for the protocol.
Leshner also explained that the initial phase of the protocol’s development was quite centralized, as expected, but that his team’s gradual efforts toward compliance to their own Meteor Rule started as soon as the concepts were proven, and decentralization infrastructure was built. In a move that would change DeFi, Compound governance tokens were then issued.
Currently, the Compound protocol allows its governance tokens to control significant, if not all, portions of the project’s code. Governance votes are associated with the code directly, meaning the community has total control over the future of Compound.
Many projects use governance tokens as a growth tool for early user adoption, however, this growth is at the cost of long-term stability and success. If governance is broken, very rarely will the protocol succeed, and oftentimes the right move is to delay the issuance of a Governance Token.
Robert’s remarks to Donna were followed by a general Q&A, concluding an engaging and educational series of events
INATBA and its 15 Working Groups and Committees are busy preparing similar events and outputs, leading the response efforts to MiCA and many other policy opportunities that will shape the international future of blockchain. Join us to have a voice in these efforts and be part of leading discussions on industry-shaping topics.