Is the Rise of Decentralized Finance an "Illusion"? BIS Thinks so!

The Bank of International Settlements (BIS) has called the growth in the decentralized finance (DeFi) ecosystem an “illusion” while detailing the development of the industry in a new report published Monday.

The global financial institution whose membership comprises the majority of the world’s Central Banks believes the disillusionment is centred on the wrong premise that the space is decentralized. In the real sense, its governing operations are largely centralized.

According to the BIS, “decentralization illusion” in DeFi existed since the need for governance makes some level of centralization inevitable, and structural aspects of the system lead to a concentration of power. If DeFi were to become widespread, its vulnerabilities might undermine financial stability. These can be severe because of high leverage, liquidity mismatches, built-in interconnectedness, and the lack of shock absorbers such as banks.”

With the clamour for the regulation of DeFi growing in recent times, the BIS said, “existing governance mechanisms in DeFi would provide natural reference points for authorities in addressing issues related to financial stability, investor protection, and illicit activities.”

The Obvious Flaws with DeFi

The BIS took the centralization narrative with a new description noting that DeFi protocols are more related to corporations. Governance powers are typically vested on a few large coin holders or insiders during token sale exercises.

The bank also criticized the high leverage that is very peculiar to crypto entities, most of which it said can be strained by “liquidity mismatches, built-in interconnectedness, and the lack of shock-absorbing capacity” the way banks are wired.

The BIS also talked down on the rise in the use of Decentralized Exchanges (DEXs), stating that the presence of high gas fees at each point in the utilization process of these platforms makes them more relatively costly use. Despite these apparent flaws, the BIS pointed out that the usage of DEXs is growing at a fast pace due to the anonymity and greater control they seem to offer.

Many crypto proponents believe that DeFi is the future of finance, one that can benefit from being regulated. Away from the fears of sustainability, many are choosing to do away with warnings from global watchdogs, including the BIS, to pursue more inclusion with DeFi.