BoE policy talk: DeFi had better implement good governance before it’s too late

The lack of regulation and good governance in the crypto sector is more than a hindrance to businesses and lack of protection for users, it is an existential threat, Bank of England Financial Policy Committee external member Carolyn Wilkins said in a talk on Oct. 19. Decentralized finance (DeFi) would be a good place to start getting affairs in order, she said.

Speaking at the University College London Centre for Blockchain Technologies, Wilkins said that the most common complaints about scamming that reach the Financial Conduct Authority, the U.K. financial regulator, are about crypto. In addition to that financial risk, investors are also concerned about reputational risk, which, according to Wilkins, is present in DeFi in abundance.

Today, UCL CBT hosted the talk given by Carolyn Wilkins @wilkinscarolyna on ‘#governance of “#decentralized” Finance: Get up, Stand up!’.
For more information, visit https://t.co/G5ie2who1y pic.twitter.com/b9colxbUdx

— UCL CBT (@uclcbt) October 19, 2022

Wilkins saw the concentration of power in “whales” in DeFi as a source of risk. In the top ten Proof-of-Stake platforms by market capitalization, the top 50 validators hold between 47% and 100% of stakes, she observed. At the same time, there is a lack of transparency about accountability. This tension is seen in the Ooki case in the United States. Wilkins said:

“We live in an inherently uncertain world. That means there can never be a set of smart contracts for every situation, and centralised decision making will always be needed when the unexpected happens.”

It is not always clear when that centralized decision making is needed or who will carry it out, however. Crypto needs to shape up quickly, as regulated traditional finance is adopting blockchain technology as well, and may go after some of the crypto sector’s market share. Wilkins said:

“Regulated firms in traditional finance are increasingly applying the underlying blockchain technology to traditional capital markets. They will be in a better position to capture this market if the crypto industry does not get its house in order, if only because they have more familiar and battle-tested governance.”

Wilkins pointed to JPMorgan’s Onyx blockchain trading network and the HQLAX collateral management platform as examples of the unfolding threat.

Regulators are acting, even if slowly, and the industry can help, Wilkins said. She recommended “industry-led mechanisms that develop codes of conduct and best practices,” regular code audits and “disclosure of how rights to change the code are determined and who holds the ‘commit keys.’”