In a rapidly changing market environment such as the one surrounding cryptocurrencies (“crypto”), it is important to understand the different forces that contribute to shaping it. In this article, I focus on describing some features of a growing subset of the crypto universe known as decentralized finance (henceforth, DeFi). I then provide a brief description of the current regulatory and legal landscape.

Unlike the traditional financial system, DeFi is purported to eliminate or greatly reduce the need for traditional financial intermediaries, such as bankers and brokers, thanks to blockchain technology. Let me first provide some background to put DeFi in context.

Crypto assets generally refer to digital assets that “utilize cryptographic primitives and distributed ledger technology (“DLT”),” also known as blockchain technology.¹In terms of DLTs, these assets generally follow either the Bitcoin or the Ethereum design.²This distinction is relevant because Ethereum’s blockchain, unlike Bitcoin’s, supports additional applications and tokens, as I next explain.

Native tokens, those directly tied to a given blockchain, are generally used for transaction purposes and as a store of value.³ Non-native tokens, on the other hand, can have multiple other purposes. Specifically, they include tokens created by so-called smart contract applications. A smart contract application is executable, automated, open-source software programs run on a permissionless blockchain (Ethereum for the most part).⁴ The tokens created by smart contract applications are similar to native cryptocurrencies in that they can be used to pay for transactions or as a storage of value, but they also are a claim on the platform’s economic value. ^{5, 6}

Tokens from smart contract applications can generally be classified depending upon their use or characteristics. A relevant category in this space are decentralized stablecoins.⁷ Stablecoins generally are designed to maintain a peg to other currencies, either “traditional” currencies such as the U.S. Dollar, or other cryptocurrencies (i.e. “algorithmic stablecoins”). For example, Tether (USDT) is supposed to be pegged to the U.S. Dollar, i.e., one Tether is equivalent to one U.S. Dollar. Decentralized stablecoins in particular, such as DAI, rely on smart contracts to function.

Tokens that do not share the pegging feature described above can then be further classified as: utility tokens, governance tokens, and equity tokens.⁹ Figure 1 below illustrates the crypto asset landscape according to this categorization.

Figura 1: Criptoactivos por categoría

Los tipos de tokens fungibles que acabamos de enumerar son todos relevantes para el segmento DeFi. Las aplicaciones DeFi ofrecen servicios financieros (préstamos, préstamos, comercio, etc.) utilizando contratos inteligentes en lugar de un intermediario financiero tradicional (banco, corredor, etc.). Para dar una idea de la importancia relativa de los diferentes criptoactivos, la Figura 2 muestra la capitalización total del mercado asociada a las plataformas de contratos inteligentes y DeFi, según los sitios web de datos sobre criptodivisas CoinGecko e IntoTheBlock. La capitalización total del mercado asociada a las plataformas de contratos inteligentes representa aproximadamente 1/4 de la capitalización total del mercado de criptomonedas. Los tokens DeFi en su conjunto, identificados por IntoTheBlock, tenían un precio conjunto de 52.000 millones de dólares, o el 2% de la capitalización total del mercado de criptomonedas. El valor total bloqueado combinado de DeFi (o TVL), una métrica comúnmente utilizada en este espacio que se calcula como el valor de todos los activos bloqueados en el protocolo de un contrato inteligente, fue de unos 105.000 millones de dólares.

Figure 2: Smart Contract Platform and DeFi Tokens Market Capitalization ($ U.S. Billion)

Financiación descentralizada

El universo de las aplicaciones DeFi puede describirse a grandes rasgos en función del servicio financiero que ofrecen. Una gran parte de DeFi son bolsas descentralizadas -oDEXs- donde los usuarios pueden intercambiar criptoactivos sin un lugar de negociación centralizado^.10 Una forma en que un DEX logra esto es con creadores de mercado automatizados (AMMs)^.11 Bajo este modelo, el contrato inteligente agrupa criptoactivos de proveedores de liquidez individuales y cualquier orden de "compra" entrante se ejecuta contra ese grupo. Se crean (acuñan) tokens para hacer un seguimiento de los activos que los proveedores de liquidez individuales aportan al pool. Se trata de tokens de utilidad conocidos como tokens LP. La utilidad de estos tokens es que representan la propiedad del pool de activos subyacente. Los tokens de gobernanza también suelen crearse para gestionar la estructura de comisiones que compensa a los proveedores de liquidez y otros aspectos de la bolsa. Los tokens de gobernanza son efectivamente derechos de voto: sus propietarios pueden votar sobre aspectos de diseño, así como sobre modificaciones de los parámetros subyacentes al protocolo^.12

Decentralized lending protocols are also an important part of the DeFi landscape. As with DEXs, lending and borrowing is automated with smart contracts. Since the lender does not know who the borrower is (and there is no bank to intermediate), most of these loans are secured with collateral – typically other crypto assets. The borrowing is not the only aspect that is coded and automated, the interest rate is as well. Here too, tokens are created to represent interest earned/owed. And governance tokens allow their owners to vote on proposals to change the design of the protocol. Economists Makarov and Schoar argue that “similar to DEX, the lending space is dominated by a few large players.”¹³

Additionally, industry experts have emphasized derivatives trading and yield farming as other financial services in the DeFi universe. Derivatives trading protocols are based on tokens whose value is tied to “an underlying asset’s performance, the outcome of an event, or the development of any other observable variable.”¹⁴ Yield farming on the other hand refers to smart contracts that aim to optimize returns by allocating investments across multiple DeFi applications.¹⁵

Otra aplicación descentralizada que se ha vinculado a DeFi, denominada estaca líquida, no tiene contrapartida en las transacciones financieras tradicionales. Proof-of-stake, o "estaca", forma parte de la validación de transacciones en blockchains similares a Ethereum. A diferencia de la validación proof-of-work, que demuestra un esfuerzo computacional superior para certificar las transacciones de blockchain, proof-of-stake ("POS") valida las transacciones demostrando un compromiso superior de recursos financieros. Con la estaca líquida, un poseedor de Ether (el token nativo de Ethereum) puede utilizar sus tenencias con el fin de validar transacciones en la blockchain de Ethereum (y ganar comisiones) sin tener que bloquear esos activos. Lido Staked Ether es un ejemplo de un token creado por el protocolo Lido con el fin de crear liquidez para los tokens Ether utilizados para la estaca.

La Tabla 1 clasifica los tokens DeFi en función de su capitalización de mercado, utilizando datos públicos disponibles de IntoTheBlock. A 25 de octubre de 2024, Lido Staked Ether tenía la mayor capitalización de mercado. En segundo lugar aparece DAI, una stablecoin descentralizada, y en tercer lugar Uniswap, nativa de una de las bolsas descentralizadas más conocidas.

Tabla 1: Tokens DeFi ordenados por capitalización bursátil

Regulatory and Legal Landscape

The traditional financial services sector is highly regulated. The Federal Reserve and the FDIC, for example, are agencies specific to this sector tasked with regulation and oversight. Regulating the financial sector has, at least, three goals: (1) prevent the use of funds for illegal purposes (such as money laundering or terrorism); (2) protect customers against fraud and manipulation; and (3) ensure the overall stability of the payments and financial system.¹⁶ As of now, these two agencies do not directly oversee DeFi. In fact, economists Makarov and Schoar conclude that, at present, “DeFi solutions do not comply with the three goals.”

Against the pursuit of the goals above, economists and legal scholars have argued that the main challenge in regulating cryptocurrencies, including DeFi, is pseudonymity and its “jurisdiction-free nature.”¹⁸ According to the IMF, the “lack of intermediaries [in DeFi applications] means that traditional AML/CFT regulation, in which AML/CFT requirements are imposed on the private sector and compliance is monitored by supervisors, cannot be applied.”¹⁹

Additionally, if financial institutions (or any company for that matter) issue securities and/or engage with securities trading, they are subject to securities laws to protect investors against fraud and manipulation. Enforcement actions by the SEC in the crypto space have led to lawsuits, both on behalf of the agency as well as on behalf of investors. Broadly speaking, efforts have centered around whether a given token is legally a security. If it were, existing securities laws requiring that a security is registered as such with the SEC would apply to them. For example, a notable case concerns XRP, the token issued by Ripple Labs.

Crypto exchanges have also been the object of similar allegations. For example, a 2023 suit alleged that Coinbase, a centralized exchange, failed to register with the SEC despite operating as a national securities exchange, broker and clearing agency with respect to 12 crypto assets on the Coinbase platform. In the DeFi space, another recent example is Lido DAO, which provides liquid staking. Of the 89 crypto lawsuits reported by Stanford Law School’s Securities Class Action Clearing House, approximately 44% (or 39 cases) contain allegations regarding unregistered security violations. Table 2 below lists these cases.

In summary, decentralized finance (DeFi) potentially represents a disruptive shift in financial systems by leveraging blockchain technology to operate without traditional intermediaries. However, as DeFi’s applications proliferate, its “jurisdiction-free” and pseudonymity nature pose regulatory challenges. Policymakers and the legal system face the complex task of protecting investors and maintaining systemic financial stability.

Tabla 2: Lista de casos de criptomonedas sujetos a presuntas violaciones de valores no registrados (litigios privados)

Referencias

¹ Auer, R., B. Haslhofer, S. Kitzler, P. Saggese, and F. Victor, “The Technology of Decentralized Finance,” BIS Working Papers No. 1066, January 2023 (“Auer et al.”), p. 8.

² In technical terms, these designs are known as UXTO- or Account-based DLTs, respectively.

³ Makarov, I., and A. Schoar, “Cryptocurrencies and Decentralized Finance (DeFi),” Brookings Papers on Economic Activity, Conference Drafts, March 24-25, 2022 (“Makarov and Schoar”), p. 21.

⁴ Auer et al., p. 1.

⁵ Makarov and Schoar, p. 22.

⁶ Another distinction is based on their fungibility. Non-fungible tokens (or NFTs) are associated with a claim to a unique digital or physical asset, or a license to use the asset for a specified purpose. Unlike other crypto assets, and as the name indicates, they distinguish themselves because they are non-fungible. In this article, I focus on fungible tokens since they are relevant to DeFi.

⁷ Centralized stablecoins, while using smart contract features, rely on off-chain entities for governance and reserves.

⁸ Makarov and Schoar, p. 20.

⁹ Here I follow the classification chosen in Auer et al. although other classifications exist.

¹⁰ Centralized exchanges are companies that execute trades on behalf of investors. For example, Coinbase, Binance, and others.

¹¹ For a brief discussion of how a typical AMM works on a DEX, see “Decrypting Cryptocurrency by Focusing on Decentralized Exchanges.”

¹² LP tokens can represent both a claim to the pool of assets as well as used for governance purposes.

¹³ Makarov and Schoar, p. 25.

¹⁴ Schar, F., “Decentralized Finance: On Blockchain- and Smart Contract-Based Financial Markets,” Federal Reserve Bank of St. Louis Review, Second Quarter 2021, p. 166.

¹⁵ Makarov and Schoar, p. 26.

¹⁶ See Makarov and Schoar, p. 39.

¹⁷ Ibid.

¹⁸ Ibid.

¹⁹ AML/CFT regulation refers to Anti-Money Laundering and Countering the Financing of Terrorism. International Monetary Fund, “Elements of Effective Policies for Crypto Assets,” IMF Policy Paper, February 2023, p. 27. See also Harvey, C., J. Hasbrouck, F. Saleh, “The Evolution of Decentralized Exchange: Risks, Benefits, and Oversight,” Working Paper, October 2024, pp. 19-20.