The debates around decentralised finance are heating up, with evangelists and critics going head-to-head.

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The potential of decentralised finance, or DeFi, to completely shake up, and potentially even replace, the current financial system is a hotly debated topic. But whether you are a crypto sceptic or supporter, DeFi is beginning to change the paradigm that the global banking industry operates in today.

In the cover feature for the September issue of The Banker, James King explores this entirely digital, 24/7, peer-to-peer (P2P) financial system based on distributed ledger technology (DLT), which is, importantly, real-time, decentralised, immutable and programmable, i.e. smart contracts.

In addition to being self-executing applications, smart contracts come with a high degree of flexibility, meaning they can be adapted to create new instruments and offerings to expand the suite of DeFi applications in innovative ways. Many proponents talk about its potential to democratise access to all financial products and services.

However, a lack of regulatory clarity is frequently cited as one of the main stumbling blocks facing the development of DeFi. For the most part, global financial regulators have yet to meaningfully intervene in the world of DeFi, but this looks set to change. The $610m hack of Poly Network, which provides bridging services between different blockchains, in mid-August has made many regulators take a closer look at what is happening outside their usual purview. Many financial watchdogs have raised concerns about the ‘Wild West’ of cryptocurrency markets, signalling that legislation will be brought in to protect investors.

A lack of regulatory clarity is frequently cited as one of the main stumbling blocks facing the development of DeFi

Traditional financial players are also taking a closer look at what a DLT-based financial system would look like: digital currency experiments by both central banks and commercial lenders are examples of the growing trend. Their focus has been on how to leverage DLT-enabled innovation but in a safe way, effectively bringing it back into the fold of a regulatory framework.

In an attempt to take the discussion to the next level, two recently published papers explore the concept of the ‘internet of value’ where value is transferred as easily, cheaply and reliably as data is transferred now, as well as the advent of tokenisation as a new way of owning assets.  

In June, Tony McLaughlin, emerging payments and business development, treasury and trade solutions at Citi, kicked off the discussion with the paper, ‘The Regulated Internet of Value’. He was testing the hypothesis that tokens are a “superior representation technology for digital value” because they are 24/7, unalterable, programmable, multi-asset and settle instantly. He postulates that: “If the tokenisation thesis holds true, then the 21st century may see the creation of regulated, global, token-based, multi-asset networks.”

SETL, a specialist firm building DLT solutions for financial markets, responded in July with its paper, ‘Realising the Internet of Value’, which considers the practical implications of a generalised approach to tokenisation of regulated liabilities. Importantly, the authors propose a roadmap including practical steps and considerations that can move the financial services industry from where it is today towards an internet of value.

Both argue for a transparent and regulated framework at a global level. As Mr McLaughlin cautions, “If the regulated sector pursues tokenisation in a fragmented manner, then unregulated networks may gain in relative significance. There is the potential, and perhaps the imperative, for the official sector to come together around a common vision of the regulated internet of value.”

Joy Macknight is editor of The Banker. Follow her on Twitter @joymacknight

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