The Central Bank of Canada reviews DeFi innovations and challenges

The Bank of Canada published a staff note on Decentralized Finance (DeFi) on October 17, which reviews the innovations that have made it popular and the challenges and risks associated with its use.

A staff memo describes Defy as a multi-layered architecture, with the Ethereum blockchain serving as the bottom layer (or settlement layer). Developers build a variety of tools and services on top of the main blockchain, including tokenization, lending and borrowing services, and more.

The staff memo sheds light on how the Diffie ecosystem will rise in popularity from 2020 and become an integral part of the multi-billion dollar crypto economy over the next few years. The popularity of the ecosystem has taken significant DeFi exposure since 2022, with several key crypto platforms collapsing, including Terra.

Speaking about the key features of the decentralized ecosystem, the staff note praised DeFi's “complexity,” which allows apps and services in the ecosystem to connect with each other. The Bank of Canada note highlighted three key areas where DeFi could transform the financial system:

Frictionless Financial Service Delivery: Decentralized ledger-based system reduces friction in legacy systems and expands the scope of financial services currently being offered Open Competition: Due to the open source nature of the DeFi ecosystem, it is open to everyone. ; Thus, it creates a way to increase competition by providing better options to the end user.Transparency: Using programmable smart contracts removes middlemen and increases transparency in the system, everything is accessible to the people who are investigating.

In addition to the key DeFi innovations that could transform the traditional financial system, the staff memo also addressed the challenges and risks associated with the DeFi ecosystem, saying, “Despite its innovations and potential, the overall economic benefits of DeFi are limited.”

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The note outlines three key challenges the Diffie system faces today: lack of real-world tokenization, high levels of interconnection, and reliance on an unregulated, centralized financial ecosystem.

The note highlighted the regulatory challenges posed by the DeFi ecosystem and the increased vulnerability in the ecosystem, leading to a number of hacks and exploits. “The anonymous and borderless nature of public blockchains complicates regulatory oversight,” the memo said.

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