DeFi and the Need for Government-Supported Organizations: A Closer Look

In the US, traditional financial users are protected by government-backed organizations that provide insurance for their deposits, protecting them from losses due to bankruptcy or bank failure. However, given the unique characteristics of the decentralized finance (DeFi) space, it is worth examining whether similar organizations will work in this industry.

The Federal Deposit Insurance Corporation (FDIC) and the Securities Investor Protection Corporation (SIPC) are two organizations that work to protect consumers from losses in traditional finance. FDIC protects bank deposits to a certain extent, whereas SIPC protects the property of broker-dealer users. These organizations are tailored to their specific goals and function well within traditional finance.

However, the DeFi space presents unique challenges that similar organizations may not be suitable for. DeFi hacks are becoming more common and expensive, and stolen funds are less likely to be recovered. Paying back users with funds from the organization is the most effective way to replace lost funds than litigation.

Like insurance fees for institutions, membership fees will be a major source of funding for similar organizations in the DeFi space. However, these costs need to be significant to cover the huge amounts lost in DeFi hacks. For example, Maker, a protocol with a total locked value (TVL) of $7.9 billion, would need to pay about $20 million per year in membership fees if the percentage risk of 0.25% is held constant. This number will not be sustainable for many DeFi protocols.

In addition, hacked assets are difficult to recover in DeFi, and taking a percentage of TVL instead of revenue would be unsustainable to cover the amount lost. More than 70% of hacked protocols had no audits incorporating exploited parts of the code, indicating the need for better auditing practices.

In conclusion, while government-backed organizations do well in traditional finance, the DeFi space presents unique challenges that require customized solutions. While similar organizations may work in DeFi, funding sources and auditing practices need to be re-evaluated to ensure their sustainability. As the DeFi space continues to evolve and mature, it is important to consider the need for regulatory and protective measures suited to its unique characteristics.