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FRM Part II · FRM Exam Part II · Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets

A supervisor notes that a significant share of trading in unbacked crypto assets occurs on decentralised finance (DeFi) platforms using smart contracts. From a regulatory perspective, which challenge is most distinctive for DeFi compared with centralised intermediaries?

The key DeFi challenge is that activity runs through code and possibly dispersed governance, so there may be no identifiable legal entity to license or hold accountable. That complicates enforcement. DeFi does support lending and leverage via smart contracts, and it is not backed by central bank reserves.

  1. ADeFi platforms always have a clearly identifiable legal entity that can be licensed and held accountable
  2. BDeFi platforms cannot support leverage or lending because smart contracts lack collateral features
  3. CIdentifying a responsible party to regulate is difficult because activity is run by code and possibly dispersed governance, complicating enforcementCorrect
  4. DDeFi activity is fully backed by central bank reserves, which removes the need for oversight

Explanation

DeFi operates through automated smart contracts and often dispersed governance tokens, so there may be no clear legal entity to license or hold accountable. This makes enforcement of rules difficult. DeFi does support lending and leverage, and it has no central bank backing.

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