Decentralized Finance, commonly known as DeFi, represents a groundbreaking shift in how financial services are structured and accessed. It refers to a new form of openly accessible financial services built on programmable blockchain systems. Unlike traditional finance, DeFi operates largely on peer-to-peer models, eliminating the need for intermediaries like banks or securities firms. Any financial market service that can be coded as a computer program can potentially be implemented as a DeFi application. A key characteristic of genuine DeFi applications is the absence of individually identifiable or controlling operators.
How DeFi Works and Its Core Principles
DeFi applications facilitate various financial market services, including token trading and lending businesses. These applications are typically built using smart contracts on open-access blockchain systems. The development emphasizes transparency, accessibility, and automation.
Since there are no central operators in true DeFi systems, the traditional regulatory framework faces new challenges. However, it is crucial to distinguish between projects without identifiable operators and those that are centrally controlled but label themselves as DeFi. The latter falls under existing financial market law.
Regulatory Principles for DeFi Applications
When evaluating DeFi projects, regulatory authorities follow several key principles:
- Technology Neutrality: Existing rules are applied to DeFi applications, abstracting from the use of specific technologies or procedures.
- Same Risks, Same Rules: If a DeFi application offers the same service and poses the same risks as traditional financial intermediaries, the same rules apply.
- Substance Over Form: If a DeFi application performs an activity that would require licensing from an economic perspective, a licensing requirement is assumed regardless of the technical or legal implementation.
These principles ensure that innovation can thrive while maintaining market integrity and investor protection.
Licensed Infrastructure for Token Trading
A significant milestone was reached in September 2021, when approvals were issued for the operation of financial market infrastructures based on Distributed Ledger Technology (DLT). These licenses were granted to a central securities depository and a stock exchange, marking the first time the Swiss financial center had infrastructures supporting the trading and integrated settlement of tokenized securities.
The Value Chain of Digital Assets
The approved infrastructures facilitate a tightly integrated value chain, covering:
- The issuance of tokenized assets
- Trading on a licensed exchange
- Settlement and custody services
Transactions are settled gross and immediately after exchange execution, without the need for a central counterparty. Due to the close linkage between trading and settlement, exchange transactions only become legally binding once the central securities depository has fully settled them from the participants' existing stocks. This offering is primarily aimed at supervised financial institutions.
This development demonstrates the practical application of the "same risks, same rules" principle in a technology-neutral manner, using existing financial market law provisions.
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Frequently Asked Questions
What is DeFi in simple terms?
DeFi, or Decentralized Finance, is a system of financial services built on blockchain technology that operates without traditional intermediaries like banks. It uses smart contracts to automate processes such as lending, borrowing, and trading in a peer-to-peer manner.
How are DeFi applications regulated?
Genuine DeFi applications without identifiable operators present regulatory challenges. However, projects that are centrally controlled are subject to existing financial market laws. Regulators apply principles like technology neutrality and "same risks, same rules" to ensure consistent oversight.
What is a tokenized security?
A tokenized security is a traditional financial asset, like a stock or bond, that has been converted into a digital token on a blockchain. This allows for faster, more efficient trading and settlement compared to conventional systems.
What was significant about the 2021 DLT infrastructure approvals?
The approvals marked the first time a national financial center had a fully licensed ecosystem for the trading and settlement of tokenized securities. It integrated a stock exchange and central securities depository using DLT, enabling immediate settlement and a seamless value chain.
Who can use these new licensed DLT infrastructures?
The infrastructure is primarily designed for and accessible to supervised financial institutions, not retail consumers. This ensures that the participants are already operating within a regulated framework.
Does 'technology neutrality' mean DeFi is unregulated?
No. Technology neutrality means that the regulatory rules focus on the economic function and risk of an activity, not the specific technology used. If a DeFi service performs a regulated activity, it must comply with the relevant laws, regardless of its decentralized nature.