The report stated, “Despite the investor’s exposure to DeFi being generally small, there are serious risks to investor protection due to the highly speculative nature of many DeFi regulations, significant operational and security exposures, and the absence of a clearly defined responsible party”.

An independent EU official cautioned that DeFi operates without trustworthy intermediaries and this could “otherwise reduce risks related to financial stability and investor protection”.

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Risks of DeFi

The report warned against the “rule is law” principle which it claimed prevailed in current DeFi governance.

The regulator stated, “Smart contracts continue to be an unregulated phenomenon, exemplified by the accepted principle’s concept of ‘code is law’”. It added that adherence to this principle creates a tendency to accept results of smart contracts “regardless of any moral or legal matters”.

The study concedes that DeFi’s automatic, immutable functions pose less risk. However, it highlighted that the developer’s pseudonym could facilitate the proliferation of illegal smart contracts.

The article added, “The pseudonyms of developers implementing smart contracts and their lack of accountability, support the rise of ‘illegal’ smart contracts like Ponzi schemes”.

The regulator said that the flexibility of smart contracts could lead to system failures.

It added in the article, “The flexibility feature of smart contracts, which allows DeFi protocols to be built on top of each other and provide various services for users, also leads to contagion risks by creating dependencies between the protocols”.

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