In the US, traditional finance users are protected by government-supported organizations that provide insurance for their deposits, protecting them from losses due to insolvency or bank failures. However, given the unique characteristics of the decentralized finance (DeFi) space, it is worth examining whether similar organizations would work in this industry.
The Federal Deposit Insurance Corporation (FDIC) and the Securities Investor Protection Corporation (SIPC) are two organizations that function to protect consumers against loss in traditional finance. The FDIC protects bank deposits up to certain limits, while the SIPC protects broker-dealer user holdings. These organizations are tailored to their specific purposes and function well in traditional finance.
However, the DeFi space presents unique challenges that may not be well-suited for similar organizations. DeFi hacks have become more prevalent and costly, and stolen funds are less likely to be recovered. Repaying users with funds from the organization is the most effective way to make up for lost funds rather than litigation.
Like insurance costs for institutions, membership fees would be the primary funding source for a similar organization in the DeFi space. However, these fees would need to be significant to cover the large amounts lost in DeFi hacks. For example, Maker, a protocol with a total value locked (TVL) of $7.9 billion, would need to pay about $20 million per year in membership fees if the risk percentage of 0.25% stayed constant. This amount would be unsustainable for many DeFi protocols.
Furthermore, hacked assets are hard to recuperate in DeFi, and taking a percentage of TVL instead of revenue would not be sustainable to cover lost amounts. Over 70% of the hacked protocols had no audits incorporating the exploited part of the code, pointing to the need for better auditing practices.
In conclusion, while government-supported organizations work well in traditional finance, the DeFi space presents unique challenges that require tailored solutions. While a similar organization may work in DeFi, funding sources, and auditing practices would need to be re-evaluated to ensure their sustainability. As the DeFi space continues to evolve and mature, it is essential to consider the need for regulatory measures and protections that fit its unique characteristics.