In a recent paper, I draw a rough map of the vast field of decentralized finance (DeFi). DeFi serves as an umbrella term for financial platform transactions that operate through automated protocols on blockchain and have prompted hard discussions regarding the public and private nature of money. With a focus on the competing understandings of risk in this debate, I situate DeFi in the context of tech-driven financialization and “assetization,” whereby everything qualifies as a tradeable commodity. I probe DeFi proponents’ promises to “democratize finance” and ask whether, ultimately, this non-intermediated, decentralized transactional system can be made compatible with principles of public democratic governance.

Fintech, DeFi, Derisking, and Who Benefits?

DeFi questions should be distinguished from questions about  “fintech” – financial technology. Fintech captures the hardware and software used to execute fundamental financial functions such as transferring, borrowing, loaning, saving, or investing funds. In playing a key role in the expanding DeFi infrastructure, it increases and broadens access to banking and investment services through the elimination of certain entry barriers. Empirically, positive, oft-cited examples tend to come from the Global South and emerging markets. That seems to make sense – because “platform” money here is “innovative” as it frequently emerges not as a successor or alternative to services otherwise offered by firmly established financial infrastructures, but as a circumvention of not yet fully formed infrastructures. Negative examples come from rogue platform bankers in New York, California, or the Bahamas. They illustrate the extreme concentration of trusted wealth in the hands of a few and, moreover, underscore the risk of bad apples at the top of investment platforms or of weakly coded smart, not so smart contracts.

If intermediaries are eliminated from transactions, and those transactions are  neither facilitated nor backed by publicly regulated financial reserves, who secures the promised funds and who ultimately protects the reliability of the regime through which transactions are channelled? What, or who, actually lies behind financial peer-to-peer transactions?

According to some, DeFi is the next phase in the constitutionalization of money – as a private medium, grounded in markets, not the state. For them, the growth of DeFi promises a decisive turn away from state-mediated and -regulated financial transactions. Like-minded proponents invoke DeFi’s positive implications for social actors’ enhanced access to banking and to economic life and beyond. DeFi’s protagonists maintain that a non-hierarchical, access-controlled system of financial transactions, housed in technology rather than in institutions, will lead to universal inclusivity and transparency. And yet, while the suggestion that DeFi will bring about the democratization of finance is ambitious, it is both exaggerated and distracting.

Skeptics point to the actual and persisting if not deepening asymmetry between those who can benefit from the evolving technology and those who find themselves further descending into debt and self-exploitation. Intrigued skeptics such as Saule Omarova and Robert Hockett challenge DeFi’s claim to autonomy as being “free from the state” and highlight the state’s role as still being the enabler and safeguard for the financial system. Other skeptics such as Daniela Gabor, Christine Desan, Isabel Feichtner, Benjamin Braun, and Lenore Palladino further point to the function of money as a governance technology and insist on the public nature of the financial system as such. They intervene at a critical juncture in which, as Daniela Gabor argues, states willingly “derisk” institutional investors in order to enlist “private capital into achieving public policy priorities.”

DeFi skeptics push back against the democratization’ claim and draw attention to the shortcomings of DeFi for its most vulnerable users, arguing that DeFi not only creates access but also perpetuates and aggravates inequality and precarity. Moreover, so-called algorithmic flaws that manifest themselves in, for example, racial bias, misgendering, or socio-economic discrimination in ADM (automated decision-making) processes in mortgage, housing, or hiring applications tend to get addressed as problems of fairness or inaccuracy. But, skeptics in the field of critical-data studies highlight the limitations of such self-referential correction. With their focus on fairness and distribution, self-enthroned “AI ethics” guardians fail in more closely scrutinizing the invasive governance and surveillance functions of platform applications. By consequence, the burgeoning AI ethics and fintech literature does not sufficiently address the structural affinities between the ubiquitous extraction of personal data in border control, policing, insurance, recruitment, and commercial contexts, on the one hand, and DeFi’s place in a broadly financialized, inegalitarian economy, on the other.

Law and Political Economy of Decentralized Finance

To gain more clarity about seemingly incompatible positions and insulated discussions one must put DeFi into a  contextbeyond historical chronology. As Steven Schwarcz recently highlighted on the Blue Sky Blog, the history of fintech goes back to the introduction of computers with significant but disruptive effects in the expansion and acceleration of services and financial markets. Technology was key in the creation of globally connected mortgage markets. We should keep this in mind when associating DeFi’s emergence with what came after the 2008-9 financial crisis. As the late Senator Carl Levin noted, the crisis “was not a natural disaster (but) a manmade economic assault.” What follows is a need to connect today’s concerns with DeFi’s risks for financial stability with the insights into the multiple multiple dimensions of risk, which we gained through the financial crisis. Hilary Allen has been pleading for a differentiated treatment of risk in how we scrutinize the potentially significant social costs of lingering financial instability. In her 2022 book, “Driverless Finance,”, Professor Allen notes how “the rise of fintech also begs broader questions about the role and limits of bureaucratic expertise in our society (particularly the ability of government experts to engage in public-serving innovation), which is in turn part of a bigger debate about the role of public versus private in our financial system.”

What are the different dimensions of risk in the financial system today? Who should and can address them? And in whose name? Is DeFi correctly claiming to respond to concerns around the functioning of a sophisticated, yet barrier-burdened, expensive, and inherently fragile transactional infrastructure? And is the elimination of intermediation and state control going to lead to a regime committed to the same public values that the existing system purports to guarantee?

Risk, What Risk?

Today’s debate about the risk of financial stability must be seen in context of the decisive and politically driven shift towards market-based finance and the commodification of public and private assets since at least the 1970s. From a law and political economy perspective, DeFi is a critical stage of financialization, not an aftermath or fundamental change of direction. Given short shrift in determining DeFi’s risk to financial stability are the connections between technology-facilitated stock market growth, uneven distribution of profit and income, and growing private and public debt. How to bring innovations to democratic economic and financial governance in the context of increasing social divisions and political polarization is anyone’s guess.

A paper that tests DeFi’s ability to promote democracy in this context is bound to disappoint; it cannot provide answers to the big and difficult questions it raises. But  bridge-building and drawing connections between debates might still be worth the effort. My paper draws on earlier work in law and political economy and engages with recent analyses by scholars Katharina Pistor, Simon Deakin, John Coffee, Nick Bernards, Ilias Alami and others who examine the role of law in maintaining of the prevailing economic and financial system. As such it prompts not just regulators, but more specifically lawyers, as guardians of methods too often characterized as politically neutral and technical, to engage in introspection and self-critique. The questions of whether and to what degree DeFi can facilitate financial inclusion is one side of the DeFi-debate coin. The other side is the question of how lawyers can effectively address the current economic, financial, and ecological crisis, which at its heart is a crisis of democratic, inclusive ,and transformative governance.

This post comes to us from Peer Zumbansen, inaugural Professor of Business Law at McGill Faculty of Law and academic lead of the Office of Sustainable Finance for McGill’s Sustainable Growth Initiative. It is based on his article, “Runaway Train? Decentralized Finance and the Myth of the Private Platform Economy,” recently published in Transnational Legal Theory and available here.