4 Application of regulatory mechanisms to decentralized finance

Abstract

Application of regulatory mechanisms to decentralized financeDecentralized Finance (DeFi) is a rapidly emerging area of finance next to traditional centralized financial institutions with decentralized protocols that are blockchain-based or operate on another distributed ledger technology.DeFi leverages the power of smart contracts, which are self-executing contracts which may have the terms of an agreement between a buyer and a seller directly written in code.This technology enables financial transactions to occur without the need for intermediaries such as banks, allowing for faster, cheaper, and more transparent financial transactions (Bergt, 2020).As DeFi continues to grow, it is important to consider how regulatory mechanisms can be applied to ensure its safety and stability.This chapter will explore the application of regulatory mechanisms to DeFi coming from a centralized finance perspective.The term "smart contract" was coined by Szabo (1994): " A smart contract is a computerized transaction protocol that executes the terms of a contract.The general objectives of smart contract design are to satisfy common contractual conditions (such as payment terms, liens, confidentiality, and even enforcement), minimize exceptions both malicious and accidental, and minimize the need for trusted intermediaries.Related economic goals include lowering fraud loss, arbitration and enforcement costs, and other transaction costs.Some technologies that exist today can be considered as crude smart contracts, for example POS terminals and cards, EDI, and agoric allocation of public network bandwidth." The name smart contract, which refers to a contract, is rather misleading, especially since a smart contract represents a tamper-proof, self-verifying, and self-executing script.While such a script can indeed also represent a contract in a legal context, since contracts can also be concluded verbally or implicitly, not all smart contracts are actually contracts or even smart for that matter (Bergt, 2020).In the words of Buterin ( 2018): "To be clear, at this point I quite regret adopting the term 'smart contracts'.I should have called them something more boring and technical, perhaps something like "persistent scripts."In his manifesto on smart contracts, Szabo (1994) suggests that the considerations for smart contracts go even further back to the so-called agoric computing, which has its origins in the 1970s and 1980s (cp.