Decentralized Finance (DeFi) empowers consumers and businesses to use financial services cost-efficiently and independently. This new financial system will likely lead to greater financial inclusion, consumer participation, and market efficiencies than the legacy financial system.
To foster Public Good Protocols, DeFi protocols should be encouraged to possess these critical characteristics, which would therefore exempt them from financial regulation:
- Decentralized: This paper conducts two critical tests to determine a protocol’s decentralized status. First, no single person or the managerial efforts of a specific or limited group of persons can (i) control or fundamentally alter a protocol’s purpose or code; (ii) control user funds or assets; (iii) reverse transactions; or (iv) restrict access to the protocol. Second, a decentralized protocol must be built on a public and permissionless blockchain to help ensure the protocol’s decentralized and non-discriminatory nature. For the purposes of this paper, base layer blockchains are assumed to be public and permissionless.
- Open source: The protocol’s software should be open source, enabling the public to view, contribute to and learn from the protocol’s technology. This avoids vendor lock-in, helps to identify and fix errors quickly, and fosters network effects through community engagement.
- Autonomous: The protocol’s smart contracts should be self-executing, meaning the rules and actions are predetermined. The autonomous nature of the protocol’s smart contracts ensures the protocol’s credible neutrality (i.e., that the protocol will not discriminate against individuals or types of transactions).
- Standardized: Protocols should use existing technical standards and/or take steps to maximize their potential composability and interoperability.
- Non-discriminatory access and use: Protocols should allow users to freely access and use the system as a form of public good. As mentioned under the ‘decentralized’ characteristic above, protocols should be built on public, unbiased, non-discriminatory blockchains (i.e., permissionless).