Tim Weingaertner - DeFi Supervision - Who's task is it?

Transcript

from my side uh we're a small group and um yeah perhaps to myself I'm um professor at the lon University of blight science so I know this settings where everybody is sitting in the back and nobody in the front but um since it's interactive I invite you to come in front if you like uh because I prepared some some work weekend to do because uh yeah it's a workshop and it's a workshop on um defi supervision and the question about who task is it so it's not that I tell you who should be responsible for

for def5 supervision uh I will introduce you in the topic but I also want to discuss this with you because it's an more or less open topic um but to start off I would like to invite and just get me this started here um invite you to I have some polls on uh on mtia I hope this works with the link um just scan the code we we have multiple uh checks uh over the lecture give you some some minutes uh just also to get to know you what is your background and why

you're attending this session so puls are coming in looks great um and I do it the the classical way to present this huh should work no is there away we can too many ways to [Music] to well I I can yeah I can read it let's do it like this I I thought we can just put it okay um so we got uh six defi

enthusiasts and uh and one fintech innovator so um that's pretty cool because we don't have any newbies uh unfortunately we don't have any uh regulatory experts okay so I I'll have to take this uh this job down uh so thanks for um um yeah you this this short overview um yeah so the goal of this session is a little bit I want to introduce into um Defi and the unique landscape and risks we have um some supervision uh other supervision challenges and um and also looking into

supervision of of um of the decentralized world and then um together work on some exercises so I keep this short because most of you know the topic of decentralized Finance but still and I added this this flowchart from a publication uh of a colleague of mine um so it's so if we look at these centralized Finance um it's always the question how decentralized is it really and this flowchart guides you through because um you have this this you can make the decision of centralized finance

and decentralized finance and it's not that clear that you uh might think um so normally we say Okay defy that's something is based on a blockchain um it's open it's permissionless so everybody can uh can contribute and um it's smart contract based so um it's automatic um we don't have any interference of people in there uh but the user is in control so that's the main idea and of course it's transparent and publicly uh verifiable and all these these kind of uh topics and I think what's also very important to understand

it's it's 24/7 so I don't have any lack time so where I say well okay um I can take the whole uh thing down it's working all the time and one of the biggest things is pseudonymity so that I don't act with my name and that's one of the biggest issues when it comes to supervision but following the flow chart it's always the question when is it centralized and when is it decentralized because not just putting a protocol on a blockchain doesn't mean that it's defi so the first question is who is on in control who has

the keys to the smart contract who can change the smart contract or alter it you there are uh several possibilities even to change a smart contract afterwards and even if this is out there then uh do I have some kind of control mechanisms um do I have a DA and if I have a DA then who owns the the voting shares um and then at the end I can also ask myself okay now I'm on a blockchain but this blockchain has some kind of uh governance model so are there some main developers that can stop the blockchain

yeah think back to ethereum when we had folk yeah so still then still even if my my whole protocol or my my application is decentralized I still rely on some infrastructure so um I think these are the question we have to ask ourself and comparing decentralized Finance with the traditional banking when it comes to risks um so that's the picture of um traditional Finance we have some kind of liquidity providers um we have the bank the classical financial institute we have a counterparty that gets loans we have a market and then outside of this

ecosystem we have the regulator we have laws and we have supervision organizations when we look into risk traditional Financial risks are three or depending on how I look at four risks that's comes also from the Basel 3 um uh initiatives and so one of the topic is Market risk so what happens if something happens on the market yeah so the whole stock markets go down what risks does this uh mean for for my ecosystem or my bank um I have the traditional credit risk so if I'm a counterparty what if I

default um so that's our risks all always from the financial institute the bank uh scene I have liquidity risks what if there's a bank run and everybody takes out it money so then I have an issue as a bank um and operational risks traditionally what happens if something in the bank goes wrong wrong decisions fraud stuff like this it system cyber security risk that's all uh operational risk or up risk so that's from the traditional part now let's switch into defi so I don't have any Bank anymore I

have a smart contract blockchain based I now have cryptocurrencies I still also have this in a traditional Finance now but here the main focus Market is the crypto Market not hackers but anonymities so I don't know who provides liquidity and I don't know who is my counterparty for example for landing protocols regulation is becoming pretty complex because um in the traditional Market if I'm a bank with a Swiss a

banking license I'm under Swiss regulation if I'm a bank in Germany I'm under German and EU regulation if I'm in the US I'm under us regulation if I'm worldwide with defi so which regulation apply that's a big question supervision today we don't have any supervision some say well it's the community that supervises um yeah that's exactly what we want to work on then other aspects like I already mentioned 247 um we don't have any banking hours um yeah

so it it's always always up always running and also what's important when you look for example at uh Landing in traditional banking you normally have maturity times so you take a loan for 3 years you invest into something for a couple of a period when you look at Defi and the whole blockchain based protocols I wouldn't say nonone but 99.9% don't have any maturity so it's always until the user takes out his money or pays back the loan yeah and

that's pretty complex to calculate risk because all the risk models mainly uh work on this duration and then when we look into the risk we have of course the risks we already have in traditional banking but in addition we get more technology risks which we can put somewhere in the operational risk part we get or we see more attacks to the market like front running and stuff like this because you can do it yeah also the question do we have some super Vision um we have regulatory risks

in a meaning that which regulation really applies and what happens if tomorrow the regulator says well okay this is forbidden yeah so you have this kind of uncertainty and you have the governance risk uh when you bring supervision to uh to the community um so for example Dow uh who really observed this and how um can I guarantee that uh those stakeholders really comply to what is meant to what we did um in a research uh perspective we looked into risks in Defi

and came up with this identification of various risks and don't worry it's small but I have this on paper for you you know the classical way as universities work um but you also need this for the workshop so everybody can take this home or also if you want to look into uh the publication I think slides are distributed so now with this I really want to step into discussing risks with you and [Music] um for this you know as I mentioned the

classical way I've got some oh can I just give this to you thanks a lot uh I have I have more if we need more paper you also can work in teams you can come up uh it's really should be a little bit interactive I know it's uh uh this kind of classroom settings is not the best way to start this and before we we work here in this I got another uh survey coming up so for those

who joined late uh you can scan this code for those who already participated in the first poll uh you should just uh can continue with the same link and um the question would be uh which risks were you the most in defi give you a little bit of time thanks so got the first

answer unfortunately I cannot present this but I'll read it loud so so answers are coming in at the moment um we are mainly worried about regulatory risks four and two operational risks so

nobody's worried about technology that's good because you all are the defi experts that uh uh develop these protocols no errors of course oh yeah okay sorry I should haven't told this because now it's coming the First Technology risk okay so um now we got one technology risk two operational risk and four regulatory risks wonderful so let's go back and one market risk two technology

risk okay um yeah so I prepared this small canvas for uh this session and the IDE is um I think you're all familiar with with canvas like uh the business model model canvas so the question is um and perhaps you can also discuss it's a workshop it's not not an exam so don't worry um so what what do you see um which risks do you see so again um we have uh two technology people who see technology risk operational risk One

Market risk and four regulatory risks so what risks do we have and who or how can we assess them that's the the question so if I have operational risks how can I measure this risk um what do you see in possibilities to to measure those risks and really happy to start a discussion with you yes and H how would you assess them or

how would you measure this just money's gone oh yeah of money lost yeah potentially lost that's that's already into measures how I can I can address this risk we'll come to this later but yeah um um this this is one one possibility uh

diversify uh the risks um so I'm open here but I think this is from a protocol perspective uh As I understood you're right but we can also from a user perspective also I can diversify I can put my money in different uh different defi protocols and hope that not all got hacked yes respons so so who is responsible for the

error and government is yeah we'll we'll come to this point it's great if you already think about Solutions I uh always tell my uh my students um and it students always start with the solution think about the problem

first yeah sence okay thanks for

input other topics we you come to mind when you look at risks and how or how can we measure or assess them yeah F fully agree I think that's that's

Al it's not the the first uh reason for uh erc20 or those token standards but also it's one reason because when I stick to a standard and I use this code then I know that all the others already used this so I can be sure it's more or less uh safe on the other hand it lowers The Innovation part of course because I stick to a standard I do whatever the others already do and when you look for example to uh to Landing protocols or exchange protocols each protocol comes up with their own individual ideas and how liquidity is provided how exchange

is done that's also the Innovation part okay so um let's go further um we already did this to two challenges um me just here so um when we when we ask ourself why do we have supervision or what is the the aim of supervision then it it's not all about um knowing what the financial Market is doing uh the so the responsibility for

supervision even in the traditional Finance is transparency so um being able to show what's happening on the market and uh and also to the users stakeholder transparency about the market um then it's all about risk management and it's always the question supervision on which level so on a bank level or financial institute it's about supervision um of this institute and monitoring and reducing the risk of this institute when you look at the country's perspective like supervision from finma or National Bank it's all about um looking into the

systemic risk factor so so uh the National Bank is responsible for the Swiss like systemic risk you had a question well yeah it monitoring is it also but also um super one of the tasks of supervision today in the financial Market is to bring transparency on the market when you look for example at uh

finma SMB uh they publish reports about the actual status of the they also have or we also have regulation that forces the financial institute to publish some standards that that's the idea behind this uh then also supervision uh or the aim of supervision is that we have integrity so um so the to make sure that uh institutes really follow the rules um we don't have any Market manipulation uh of course Financial stability this comes to together with the risk management consumer protection

so um that I'm as a user or participant in this ecosystem is uh I've saved from this also when you look at the traditional banking we have some kind of funds so if a bank goes bankrupt uh I get at least some part from my money back from this fund um then comes the the legal side yeah supervision also uh enforces compliance with the law and one of the laws is know your customer or anti-money laundry counter uh financing of uh terrorism and stuff like this and also to prevent Monopoly so when you'll

ask a super umv visor uh from a financial perspective what are your roles these are the roles now the big question about uh Financial or Supervision in in the defi space is what is your opinion um who should be responsible for Supervision in the defi space and um I also gave you multiple choices so you can decide how how much they should be um responsible and for those

who are new in this space Dy do your own research so that's the traditional part you say Okay user if you participate in this uh uh space um you're responsible for your own Market you have to do your research and if you invest in a protocol that's fraud then yeah your research was wrong and one one question also uh you find the the node operators the validators I think with proof of stake uh validators now not minus anymore they are validators and validators could also

validate further points so that's the question should we uh enforce those validators that they take additional Parts in this ecosystem what is your opinion yeah but I think that's that's the open

question is it that you as you mentioned that um a game theory behind this whole validation makes it impossible that validators really act on the best behalf of the users but on the best behalf of of themselves

[Music] mhm so when I look at the results um it's a little bit a putt so uh we have uh a slightly winner between uh the classical regulator finma uh the developers and the da um also uh the user should be responsible the community should be responsible none of the above um that that's a a great um part who voted for

none of the above and has some great new ideas nobody you want to ask or you you so not the country based okay so so there we we should have some some Global unit that regulates defi as a Global Financial system yeah we open it's a workshop it's not some

other the legislator who is the legislator Swiss Parliament or or the US Parliament for each okay other opinions so so the idea is doing a ramp up phase

we have the traditional like finma H until we get this kind of big uh Dows that uh that are able to uh to supervise uh this okay so yeah um let's discuss or work on uh the right part so um so I just put two columns one who are the stakeholders and what is their Duty um you already filled out this uh um this poll and perhaps you can also look into this and uh know from

from your opinion who are the stakeholders what are their Duty in this whole defi ecosystem again also discuss with your neighbors which is hard in this setting who distributed yeah we are talking about distributed decentralized Finance so it's completely great that you are distributed in the whole room other opinions on this uh are there there any stakeholders we haven't touched yet there in your opinion all all and each uh each one has their

Duty or different to it you are so the idea is uh to to list them and also uh on the right side list to each stakeholder what is her or his duty on this on this topic okay let's move on um so the idea of um of this uh governance uh column is to bring those

sides together so we on the one hand side we have the risks and how we can measure them your ideas on the risks and measurements and on the other hand we have the stakeholders and their duties and how can we uh bring them together so how can we form or formulate methods or protocols that uh each of the stakeholders can fulfill their Duty uh and reduce or control the risks what are your opinions on this standards so learning from from

failures but we I I think also in the traditional Finance we learn from failers so there is a big issue financial crisis to 89 and now we make new regulation and we have this kind of liquidity uh reserve and all this stuff yeah the the big issue is um we first have to lose money to to learn and the other question is how do we how would the record this these issues and how can we educate the financial

Market should there be a joint database for for issues what what is your opinion on this service

Prof okay so we we take them in charge who make the big money the the big question is who takes

them into account and I think also in in defi it's always the question if it's if it's a country-based regulation what prevents them from switching countries just going to another country where there's not this regulation yeah MH yeah

open open to your so yeah I think if you thought about governance and bringing stakeholders or linking stakeholders to to risks and how we can observe this um so the next question I just have to switch here um yeah so the uh the next question would be [Music] um what do you think from the above how can this compliance be be measured or should be measured so um what what kind of standard or

measurement standards should we introduce into defi to assess the risks um and also that so our goal is to ensure that defi operates correctly legally correctly with our uh ethical standards and I know that's at this point when we go worldwide there are different ethical standards I know uh but I think uh transparency and nonf fraud are compliant with all countries that we don't have or we we don't see this as ethical so what do you think about

measure uh yeah possibilities or measurement possibilities it's it's again uh when I come back to uh the the goals of supervision so to fulfill or in order to fulfill those goals what measurements should we should we take okay so major what what what makes me a

major player the big five protocols D5 protocols okay like a and Mead and those I think yeah yeah okay yeah yeah I think that's that's a good idea to to say okay then we make an audit um the the big question is um when I become famous my smart contract is always uh already deployed um then I audit a smart contract I

cannot change anymore that's the question or I make a new version or hey my product is bad please don't use it but use version two yeah valid yeah MH but but who should be the auditors okay so the regulator should appoint

some audit companies like like the big five and new new business for km and all the others okay yeah good idea yeah security topics you mean technology risk

like mhm so so the the the market resolves it itself some kind of bounty system because the the big question is um uh how do those uh errors really come up and arise or what prevents me from a

developer when I find this uh this topic that I wait until there is enough cryptocurrency in this and then pull it out and then yeah really uh yeah make a bigger damage yeah yeah and I think smart contract code is is getting pretty complex and especially if you then combine products with other products it's much more complex and to

say okay finma lucky you so far you just observed the traditional banking but now here are a thousand smart contracts go for it find the error mhm leave this to the community okay sure C

can EXP so coming up ISO standards for mhm okay so just looking a little bit on

the time and want to come to our uh last uh box in this uh in this topic now we with um we discussed risks and who is responsible who should be responsible how can we measure it and then the question question is how should we report it so the question um who should report what to whom yeah so for example the developers technological or security issues to the community or to whoever who should be the uh

the receiver of these reports what do you think mhm good other opinions

mhm so like the the regulator collects or gives some some standards and then uh collects this and then publish it to the to the community mhm yeah okay great so I think thank you for your inputs um as a conclusion from my side um it was fun having also a small group having

this Lively discussion um even in this large uh setting um also for me very interesting what what's your opinions about who should work on this uh whole supervision I think when we observe the space there will be be more regulation on this so more um and and I think it's also it's it's also uh because there are more institutional investors coming into this space and they want to have some kind of certainty uh so they want risk management that um so there are the the voices that there has to be some regulation and also some supervision

about about this uh from my perspective the biggest issue is we are in a global worldwide market so who is the The Authority that takes this role um as you mentioned before perhaps at the beginning we have to have the traditional um players and then going into a DA and we we had a lot of discussion about regulation in Dows and does it work or work not so that's uh interesting to see um so for in the University we always ask at

the end uh how do you uh rate this Workshop so I invite you to give feedback on the workshop how satisfactory this was to you it's an open discussion I think we all learned from it I hope so thank you very much for this feedback and I got a a last poll um which of the aspects was valuable for you most uh

uh value the group discussion and I think that's uh that was great even if it was a small group uh a great discussion thank you from my side for attending this Workshop I hope you uh also took something with this um and I wish you uh nice upo afterwards thank you