The Bank for International Settlements has peeked under the hood of decentralized finance (DeFi) in a new working paper, presenting a DeFi Stack Reference (DSR) model to illustrate the technology’s functionality and risks. The report discussed the integration of DeFi with traditional finance and suggested ways to assess its risks during this integration.
Paper researched architecture, technical primitives and functionalities of DeFi protocols with considerable technical details. “A deep understanding of DeFi is still lacking in many circles,” the authors wrote, “requiring a specific framework for a better working knowledge of the technology.”
The effort is worth it, the paper argued, for the sake of DeFi innovation:
“It is still unclear whether and to what extent DeFi will expand in the future. […] Nevertheless, we consider DeFi a relevant development because it uses innovative technology that could shape the future financial ecosystem.”
Algorithmic automation, “competitive financial engineering” and transparency “are of interest beyond cryptocurrency markets,” the paper said. By competitive engineering, the authors meant composability, combining smart contracts into complex and unique financial products.
The DSR model divides DeFi into three layers: interface, application, and settlement, with sub-layers allowing for variation between DeFi technologies. The paper used various tokens, blockchains and financial services in its examples. Running on Terra (MOON) has been discussed in detail for its informative value and as an example of the effectiveness of the authors’ investigative technique.
This working paper was released the same week as The World Economic Forum (WEF) published an overview decentralized autonomous organizations. The two works are highly complementary as the WEF publication was equally comprehensive but non-technical.
#DeFi is a programmable financial ecosystem that allows users to trade, lend and invest without relying on a central intermediary. This paper takes a deep dive into the underlying technology, its economic potential and the associated risks https://t.co/NLkvja6Not #Ethereum #blockchain #DLT pic.twitter.com/EnccGmmf93
— Bank for International Settlements (@BIS_org) January 19, 2023
The BIS regularly participates in central bank digital currency research. She took a very cautious stance on cryptocurrencies. It recently introduced a 2% cap on crypto-assets in the reserves of internationally active banks with effect from January 1, 2025.