DeFi
Building Investor Confidence in DeFi: What Can Protocols Do?
The meteoric pace with which the decentralized finance (DeFi) sector has made breakthroughs has raised alarms among regulators around the world. Caught off guard by the meteoric rise of the DeFi industry, regulators are now scrambling to put new regulatory frameworks in place, unsure to what extent they will be able to exercise control over it.
With the crypto market recently hitting new highs this year, in line with the optimism sparked by the first Bitcoin ETF and the last halving, the regulatory conversation has taken on even more importance. However, given the complexities associated with the DeFi industry, a global regulatory framework is not being considered anytime soon. Therefore, in such a volatile atmosphere, the DeFi sector must come up with self-regulation and out-of-the-box thinking to ensure that investor confidence remains intact in the sector.
Why does DeFi regulation seem complex?
DeFi regulation is a complex topic due to the unique nature of decentralized protocols, which no single entity controls. For more than a hundred years, financial regulation has evolved based on the concept of a trusted intermediary having total authority over each actor in its financial ecosystem.
This centralized entity can be held accountable, providing consumers and businesses with legal recourse if they feel cheated. DeFi replaces these intermediaries with programmable, autonomous smart contracts that are not beholden to anyone. Such a decentralized model presents a unique set of challenges for regulators accustomed to making changes in centralized systems.
Empowering DeFi
Having already mentioned the problem of regulating the DeFi industry, it is also necessary to introduce accountability into this sector. Without any regulations to govern it, the best DeFi protocols can do is rely on existing rules and processes from the traditional financial industry that can help them avoid taking unnecessary risks.
For example, lending protocols could use existing best practices from traditional finance to identify the most suitable borrowers. They can also borrow from existing structures that help streamline the lending process and improve the efficiency of their operations.
How can DeFi protocols use data from traditional markets?
The world’s largest economy, the United States has built an extensive structure and model for securing loans and attracting capital. Credit rating agencies such as S&P Global Ratings, Moody’s and Fitch Group have detailed data that can be used to establish rules regarding who is and is not eligible for borrowing. This data can enable DeFi protocols to make better risk management decisions.
Additionally, the United States has a strong legal system that can be leveraged creatively by DeFi companies, to ensure that their users always have avenues for legal recourse.
Zivoe: an original approach to empowerment
A company that tries to be creative to reassure its users is Zivoéa real-world asset protocol that offers an alternative source of credit to consumers tired of the predatory lending practices of the traditional lending market.
Zivoe is able to provide a more affordable alternative source of credit by providing on-chain loans to consumer lending companies, who can, in turn, offer their customers fiat loans at attractive rates. To manage risk, Zivoe secures the loans it makes to lenders by creating a “special purpose vehicle” or SPV, retaining authority over that entity in case the original lender fails to perform.
This is a new structure that reduces credit risk while optimizing the use of capital. Under this model, Zivoe SPVs can allocate unlent funds to other DeFi protocols to create an additional revenue stream. This means that the capital under Zivoe’s control never sits idle, but rather works to improve the overall health of the protocol.
Zivoe’s initial lending partner is a self-created company called Zinclusivewhich is largely run by the same management team.
Every loan Zivoe makes to Zinclusive is collateralized, and the consumer-focused products created by the latter will be placed in an SPV, which serves as a form of actual collateral. The SPV notably has no interaction with blockchain-derived capital provided by Zivoe’s liquidity providers, but its legal agreements with Zinclusive mean that these on-chain activities are connected to its off-chain assets. These agreements provide in particular that in the event of default by Zinclusive, Zivoe has the power to take control of the SPV concerned and the consumer loan portfolio under its management.
Zivoe’s unique model was conceptualized by a founding team led by the CEO Jay Abbasi and general counsel Kristal Gruevski. Meanwhile, Zivoe’s risk advisor Walt Ramsey he previously helped develop risk management strategies for Lloyd’s Bank, JP Morgan Chase and other financial companies.
Conclusion: DeFi must earn investor trust
Just like traditional finance, there is no guarantee that investors’ DeFi deposits will generate a profitable return. However, an established regulatory framework in the Trad Fi sector has at least ensured that investors have an authority figure they can go to with complaints.
This is where the DeFi industry is lagging behind and it is up to new companies showing creativity to gain the trust of investors. Zivoe is an example of creative thinking where investors are convinced that the dynamic and pioneering new form of financing is trustworthy.