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What is Decentralized Finance (DeFi) and How Does Its Work?

Defi

I. Introduction

What is Decentralized Finance (DeFi). It is a growing area in financial services.  Research showed that in past few years specifically in 2021 it has shown immense growth and promotion. Billion dollars assets were sealed in this system. According to the recent statistics, a huge drop is reported in the crypto costs whereas DeFi standards have stayed supplementary.

As we know that DeFi’s future is very difficult to be predicted. It is obvious that legal questions are introduced by DeFi that are addressed by courts and regulators. This article would discuss about some of these challenges. After the introductory basics of DeFi, this article will start discussion on the laws and principles of DeFi, whether and how it should be regulated under the Swiss financial market laws.

II. What is Decentralized Finance (DeFi)?

As it is obvious by the name, commonly the aim of DeFi applications is considered to be decentralized. The goal of decentralization is to give decision making strength or power to the citizens or their elective representatives.

In DeFi, the need of financial mediums is replaced by the modern technologies that helps citizens through one or more software protocols to perform transactions with each other which is specifically known as ‘peer-to-peer’.

Access to DeFi does not require any permission. Everyone has the access to it: There is no need of any administrator or his authorization for the access. Moreover if anybody has the necessary know-how then he or she can easily view or review the block chain technology which is generally based upon open-source software codes.

III. Applications of DeFi private laws:

Applications of DeFi are used frequently world-wide, Because of this it is more likely that if there are any disagreements which will arise because of its representation, then the DeFi protocol will have an impact world-wide. In this instance, it will be necessary to evaluate the applicable law as well as the appropriate court.

A. Determination of the Court:

1. Resolving of Disagreements:

By using the new distributed ledger technology (DLT) people does not have any restriction on choosing the location where their disagreements could be resolved. Only in the case when there are rules for resolving different types of disagreements people cannot decide the location by their own. So according to DeFi there are different rules for different types of disagreements, it states that simply being a part of block chain network does not mean that everyone will agree on the same rules for resolving disagreements.

2. Jurisdiction rules:

According to the Statutory jurisdiction rules, if a place or location is not decided for resolving the disagreement then the court will work on it under the principle of rules that will apply on the type of disagreement. Court would have to determine the rules applicable to the situation and then decide which court will resolve the issue and hearing.

As we studied earlier that the use of rules depend on the type of disagreement. It states that if the disagreement in linked to membership or token then the company will handle the case and resolve the issue by the given rules. Nonetheless if the disagreement is connected to contractual claims then the rules will decide which court has the right to handle the case or resolve the disagreement.

B. Applicable Law:
one must know that how to decide the right law for the right situation for better results. In Swiss PILA law, people have the choice to choose any law which directly fits in the right situation. It also has a limit that if the rules (chosen by people) go against the mandatory rule then it is not applicable. Simply being a part of block chain network does not do enough, as a part of block chain network one must do consent for it.

DeFi

C. DeFi application in Swiss Law

If the use of DeFi protocol and Swiss law application hurts anyone than it must be inquired that if the chosen rule was right to consent for the person or not means that if the person was applicable to use the rule or not. There are three general types of claims of the Swiss Law, it would be checked that which one of these would apply on the type of situation.

Claims:

This generally states that if two parties make a contractual claim then they must have an agreement showing that they both agreed to enter into the agreement. In a sense we cannot apply regular contract rules to DeFi because DeFi’s new unique features like being anonymous, decentralized, and accessible to everyone, so it is very difficult and challenging to fit DeFi into these types of traditional contracts. DeFi works on its own principles and rule it is impossible to use DeFi according to the regular contract rules.

People do not take responsibility for the DeFi protocol. Likewise, there is no specific person assigned for the creation of DeFi or taking responsibilities of it. Often creators of DeFi do not make themselves responsible for its rules or regulations. Or if someone is involved in the responsibility then he or her does not consider themselves as a legal or natural part of it.

Claims on enrichment:

Basically, if anyone wants to reverse a transaction or if they do not want it to be transferred by the smart contract in his modern world they just cancel it out, whereas in the world of DeFi it is not possible to reverse a transaction on the grounds of claims of unjust enrichment. Even if the transaction is not manipulated or it followed DeFi protocols it would not be reversed.

IV. DeFi’s Considerations:

A. DeFi consideration and traditions:

This generally describe the main difference between the world of DeFi and the traditional claims and regulations. Challenges of DeFi are spread along the Swiss financial markets where the concept of central operator is being used from the beginning. But DeFi offers something different and new, it does not need any central operator or a specific person for a specific task. It does everything based on its protocols, it is accessible to everyone.

B. Regulation of DeFi

So, it is being discussed that how DeFi should be regulate and the various options of law makers to regulate DeFi are being discussed. The lawmakers think about having different choices whether they should not overwrite the existing rules because the existing rules are sufficient for everyone, or they think that they should specifically create separate rules. The main idea was concluded because in many countries the existing financial markets like Swiss market are not capable to address applications like DeFi.

DeFi License requirement:

Software developers simply create or manage DeFi protocols. Even if the protocol is out of reach of other people or deployed on the block chain network, but the software developers have some special keys so that they can make changes to it whenever it is necessary. When DeFi protocols become fully decentralized the developers take control over the DeFi application and make the regulators require license from the developers.

Requiring license for creating DeFi protocols from the developers is the only and best idea because sometimes the developers could use fake information or work from different countries use fake data which may lead to destruction in future, so a license makes it easier for the regulators to choose a right developer.

DeFi Services Providers:

Companies or industries who provide DeFi services will now have to carry a license that will show that this company or industry has full right to provide the DeFi services, without the license no one would be allowed to provide DeFi services.

When it comes to opting a right option between two, the company has two options or rules given by the regulators. These rules are for those who want to provide DeFi services. One is that regulators should require a license before allowing anybody to provide the services. The second one is that the providers of interface should allow the users to provide the services with full access.

Prevention of threats to DeFi

Some investors try to steal DeFi’s data and protocols. But DeFi also has a solution for these types of scammers. DeFi blocks and warns these types of investors using network blocking. Network blocking includes redirecting some warning pages for these people when they try to steal data or misuse DeFi application.

However, Switzerland has used the networking technique to block such websites who promote the scam. But networking is very less effective on DeFi applications because DeFi applications are decentralized, and they do not rely on such websites. So, people who have a little information about the use of technology, it is easier for them to get the access through restrictions.

DeFi

DeFi protocols certifications:

Here another option for the protection of DeFi protocols is being discussed that there must be some requirements for a candidate, if he or her fully meet those requirements then a quality label (certificate) should be awarded to them to show that they are capable of it. This certificate may be rewarded by supervisory authorities or private institutes.

In the world of crypto new market in crypto assets (MICA) regulations are introduced by the EU. EU introduced a principle that will govern the issuance of MICA to regulate the issuance of other crypto assets and existing regulations like MiFID II EU market abuse.

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