IOSCO report highlights the evolution of the DeFi sector

With the increasing participation of people in DeFi or Decentralized Finance, regulators all over the world are increasingly trying to understand and regulate the emerging industry by conducting research and studies. On Thursday, the International Organization of Securities or IOSCO published a report on DeFi aimed to give a better perspective to the industry and highlight some areas of concern to regulators. It says:

“As DeFi continues to expand, both a granular and holistic understanding of the DeFi market will improve authorities’ ability to understand the regulatory implications of this emergent market with respect to their own jurisdictions. “

The building blocks of DeFi by IOSCO

For purposes of the report, IOSCO presented the DeFi technology stack in four “layers” along with a grouping of external, off-chain inputs that connect to multiple layers:

1. The “settlement” layer – Participants and smart contracts have addresses that can hold crypto-assets and interact with other participants and smart contracts in blockchains and “Layer 2” solutions where the consensus state of the blockchain is maintained.
2. The “asset” layer – Cryptocurrencies that smart contracts and participants create and transfer on a blockchain.
3. The “smart contract” layer – smart contracts (and auxiliary software) used to provide the functionality to DeFi products and services.
4. The “application” layer – Participants can interact with smart contracts through front-end user interfaces, APIs, and other programs. These applications are currently mostly hosted off-chain.
5. Off-chain inputs that can affect the application, smart contract, or asset layer, as part of a “DeFi supply chain” of information, services, and assets.

A number of financial products, services, arrangements, and activities in the DeFi industry overlap with more traditional finance operations, according to IOSCO.

As a result, IOSCO advised regulators to be aware of the ramifications of DeFi developments in their respective jurisdictions. As the DeFi market grows, IOSCO observes that regulators’ capacity to draft regulations relevant to their domains will be aided by “a granular and holistic understanding of the DeFi market.”

The biggest fear that DeFi brings is vulnerabilities and attacks but research by CertiK says that Centralization vulnerabilities are the primary reason for such incidents. A report from October said that DeFi accelerates the growth of the Blockchain and NFT sector.