Bank of England warns about the risk associated with DeFi

Bank of England is not convinced that DeFi has the ability to solve financial risk after the FTX implosion.

Bank of England pessimistic about DeFi and risk management

On Monday, November 21, 2022, the deputy governor of the Bank of England, Jon Cunliffe, warned that decentralized finance protocols do not yet provide an effective way to manage risk. This warning was issued in a speech titled; Reflections on DeFi, Digital Currencies, and Regulation, which was given at Warwick Business School’s Gilmore Centre Policy Forum Conference on DeFi & Digital Currencies.

During the course of the conference, John Cunliffe told the audience at the Warwick Business school that DeFi’s claim that a code can manage risk instead of intermediaries is yet to be proven. 

“From the perspective of a financial stability authority and a financial regulator, I have yet to be convinced that the risks inherent in finance can be managed effectively in this way,”

Cunliffe compared DeFi protocols to autonomous vehicles, noting that both are only as good as the laws, software, and sensors that control their operation.

While emphasizing his distrust and pessimism toward DeFi and its ability to deliver its claims, he said,

“Moreover, it is unclear to what extent these platforms are actually decentralized,” he added. ”Behind these protocols usually sit firms and stakeholders who derive revenue from their operations. Furthermore, it is often unclear who controls the protocol’s governance in practice”.

Uncertainty about the prospect of DeFi for risk management

Cunliffe said the Bank of England would consult next year on the regulatory framework for digital asset payment systems, which includes the use of wallet-like services.

Once the so-called Financial Services and Markets Bill is passed through parliament and becomes law, the central bank and the Financial Conduct Authority will have additional powers to oversee stablecoins and other crypto-related technologies.

He added that the UK Treasury would consult on extending investor protection, market integrity, and other regulatory frameworks that cover activities involving crypto assets and the promotion and trading of financial products for entities.

“The UK Treasury will also consult on how to extend investor protection, market integrity and other regulatory frameworks that cover the promotion and trading of financial products to activities and entities involving crypto assets,” Cunliffe said.

He said that at the moment, only the anti-money laundering law applies to those activities.

Cunliffe has been Pessimistic about DeFi and its risks before the issue with FTX. In September, he registered his unbelief when he said at a conference organized by the organization for the financial industry, AFME, that “new trading and settlement systems must deliver the same amount of resilience that regulators anticipate from the current system. It was not apparent how blockchain-based platforms and current technology would interact, and instant settlement necessitates that money and securities be available when a trade is made”.

“Simply put, there isn’t enough time to spot or fix mistakes before they have an impact. In other words, not all markets should have trading and resolution that happens instantly “Cunliffe said.