In our new working paper, From Centralized to Decentralized Finance—The Issue of ‘Fake-DeFi’, we focus on decentralized finance as one of the latest buzzwords in the FinTech space. While decentralized finance, stricto sensu, is defined as a financial infrastructure where no single entity holds control over codes and operations, and decisions are made by consensus of users, we find that the reality is often a phenomenon we call ‘Fake DeFi’, that is, a decentralized application in which innovators/developers or certain service providers hold ultimate governance rights, or the technical equivalent of governance rights, with which they can modify the fundamentals of the decentralized network.

The reasons for Fake DeFi are partly legal and regulatory, but for the main part Fake DeFi follows from the logic of markets: innovators want to capitalize on their inventions. Making profits in a fully decentralized network is incredibly difficult. Hence, innovators turn to the less difficult alternative of creating only partially centralized networks and services over which they hold various degrees of control. Thus, Fake DeFi will remain the eminent business model even if law and regulation provide legal and regulatory certainty and smooth supervision for cross-border, fully decentralized networks.

Fake DeFi requires a regulatory response. Policymakers tasked with regulating Fake DeFi as a widespread phenomenon are encouraged to review laws and regulations relating to ultimate governance rights and modes of control. Rules on the solidity of major shareholders and beneficial owners, fitness and propriety of key personnel, organizational and prudential requirements of dominant shareholders, as well as the definition of financial services groups need to be reconsidered to reflect ultimate governance rights as technical, rather than legal, modes of control.

Linn Anker-Sørensen is a Lecturer at the University of Oslo and Nordic head of decentralized finance at EY Tax and Law.

Dirk Zetzsche is a Professor of Law at the University of Luxemburg.