Hello Tracer community!
So far, most of the conversation around regulating DeFi has been spent on matters of conduct: which players need a licence, transactions processed in line with AML/KYC regulation, etc. Comparatively less has been said on the prudential implications of DeFi.
I like this recent quote from our own @Jasonpotts on DeFi’s eventual significance: ‘This isn’t a retail technology, it’s not something you buy in shops; This is an infrastructure technology, the pipes and the roads.’
Accelerating trends towards centralisation in Derivatives Markets
If I go back to first principles, the gauntlet thrown down by DeFi has been to challenge traditional finance’s central premise that transactions must rely on trusted third-party intermediaries. And far from backing away from that premise, Tradfi has doubled-down on centralising the derivatives markets since the GFC.
Specifically, policymakers have relied on 2 main levers to push derivatives markets towards centralisation. The first (and the most direct) has been to impose legal requirements for particular derivatives instruments to be cleared through a central clearinghouse. The second has been to raise the cost of trading derivatives on a bilateral/OTC basis by mandating a minimum amount of collateral (‘margin’) that needs to be exchanged between counterparties. The aggregate effect of these regulations has been to push a growing volume of the derivatives trade to be clearing through central clearinghouses.
The impetus behind this regulatory trend is to avoid a build-up of systemic risk in derivatives: so the thinking goes, increasing collateral amounts and dragging derivatives trades into reputable, well-credentialled clearinghouses is key to avoiding a repeat of the 2008 GFC. The irony however as pointed out by certain commentators is that this hasn’t reduced risk, so much as transitioned it to a different, and arguably less regulated corner of the finance sector: we have an illustrative example of this in Australia, where a proposal to bolster the RBA’s powers to assist (and if necessary, wind-up) clearing and settlement facilities that run into trouble is only just getting off the ground.
All well and good, but this all strikes me as a bit of a band-aid solution: central points of failure will always exist in a centralised system. By contrast, DeFi eliminates the possibility for a central point of failure rippling across the global financial sector entirely by reconfiguring transactions to be settled on a peer-to-peer basis.
One of first things to catch my eye about Tracer DAO was that its Perpetual Swaps White Paper offers a comprehensive blueprint for how a decentralised derivatives market might work in practice. In this, the function played by oracles will be particularly important: not just as a means of unlocking new markets, but to reduce volatility in on-chain/crypto economies through the regular provision of price information on tradeable assets. It’s great to see that thinking on oracles within Tracer is already developing, and it’ll be interesting to see how get deployed to open new markets and to mature existing ones.