Nathan Wunderli ‘23
Sports Editor
My first foray into the world of finance began several months ago. I opened a brokerage account, put some dollars in it, and have since watched the market swing wildly, but overall trend downward, as my precious few dollars have tragically turned into even fewer dollars. Of course, I made a day trade once about a week ago and made like $60 I wouldn’t have made otherwise, so basically I’m a financial genius.
This week, the Virginia Law and Business Review hosted several high-profile speakers on the topic of decentralized finance (a.k.a. DeFi). The panel consisted of CEOs, attorneys, and an SEC regulator. Decentralized finance, put simply, is finance that utilizes open-source software and blockchain to make financial deals instead of having large banks control everything from loans to contracts and other deals. So, anyone can control the way they give and receive money, the transaction is open for everyone to see because it’s posted on a ledger, and it doesn’t have to go through several large financial institutions first.
Pictured: Event panelists and VLBR president. Photo Courtesy of Lauren Johnson, '22.
There are several potential advantages to decentralized finance. First, a system where anyone can create financial tools the way they want can lead to more innovation and eventually lead to widespread adoption of the best practices. Second, it makes supply chains more efficient, by making it possible for all the parties in a supply chain to be on the same system. Next, depending on your views on algorithms, it can cut out a lot of the human biases in today’s system that can often lead to disparate outcomes. Of course, algorithms can lead to disparate outcomes as well, but at least an algorithm can be fixed–unlike a biased human being. Finally, transactions are far simpler with decentralized finance. While something like a Venmo transfer may look simple from the outside, it actually is a complicated, multi-step process. When a bitcoin is transferred, on the other hand, it is just A to B and posted neatly on a blockchain ledger.
Decentralized finance has been growing rapidly. DeFi coins have grown from ten billion in January of 2020 to eighty-eight billion in January 2022. Countries in Africa have been quick to adopt its principles, allowing for access to loans and the transfer of capital on more informal channels. Other countries with relatively open economies, such as Singapore, have also shown signs of adopting DeFi. The U.S. as a country is at an inflection point, where it can take advantage of the benefits of DeFi, or smother it through regulations. The panel was in favor of less regulation, but saw DeFi moving forward regardless of what the country does. The panelists compared this new way of finance to the progression of the internet. At one point, the internet was just for reading documents on a screen. Now you can edit it yourself, make webpages, blogs, and interact with it rather than just passively viewing it. However, that change almost didn’t happen. Regulators were close to stifling the progress of the internet, putting regulation over growth. Fortunately, this did not happen and the internet is the way it is today. The panelists posed the question: What if we are at a similar point today, where we can choose growth over regulation and move DeFi along, or keep the system as it is today? How would life be different in 20 years if we went one way or the other? The panelists seem to agree that the benefits of democratizing finance outweigh the risks and it should be regulated in ways that promote it rather than stifle it.
One way to regulate it positively is to provide a safe harbor rule for those creating a DeFi system. Because even a DeFi system has to be created, coded and controlled on the backend at the beginning by a few people, it can’t actually start out decentralized. It is later on that the creators back off and leave it to the people. A safe harbor rule will allow a certain amount of time to transition to decentralization. If it becomes decentralized in time, it would not be classified as a security and will avoid a lot of regulations it otherwise would have to deal with.
Fortunately for lawyers such as us, there will be plenty of room for our services; as there are in the current system. There is a big question about how to assign liability if something is programmed poorly in a decentralized system. Unlike now where we can just blame the bank where the transaction originated, a decentralized system is more difficult to assign blame. A new set of rules will have to emerge to deal with this problem. As for hackers disrupting the system, the panelists did not seem to think that is an issue. Or rather, it is an issue, but not any more of an issue than we would have without a DeFi system. If anything, it is easier to find the perpetrators on a DeFi system because everything is open source.
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nw7cz@virginia.edu