Listen to the Article: IMF: How DeFi and TradFi Could Save Each Other Amidst Global Economic Recession

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Since last year, the cryptocurrency industry has been going through a painful winter. In particular, the FTX debacle has caused a crisis in the entire crypto circle to snowball. Various digital tokens have depreciated, and several major crypto lending and investment companies have gone bankrupt. Just this week, Galois Capital​, a crypto hedge fund specializing in OTC trading and algorithmic market-making, also announced on Twitter that it had lost nearly half of its assets in the FTX incident and had to close its flagship fund.

Crypto is Declining, Traditional Finance is Struggling Too

To be fair, however, traditional finance (TradFi) is not doing well either. Currently, inflation is at its highest level in 40 years, the Russia-Ukraine conflict has disrupted the international monetary system, energy and commodity crises, and the three-year-long COVID-19 pandemic have caused famine and political unrest. Therefore, while we lament the crypto winter, TradFi has in a sense also become its brother in misery.

The International Monetary Fund (IMF) stated in an article that for DeFi and the crypto community, the two must be integrated into the regulatory framework that maintains traditional financial stability to be accepted by the mainstream. But the global economy as a whole is also facing urgent problems, such as the energy crisis, whose essence is not due to a shortage of energy or inadequate energy conversion technology, but the failure of energy financing. According to estimates by a think tank in San Francisco, the world invested $632 billion in 2019-2020 to combat climate change, far below the $4.5 to $5 trillion annual net zero emissions funding needed. The main reason for the funding shortfall is that investors lack confidence in projects that have a sufficient return and impact. However, the innovation of DeFi and the crypto community can address the problem of the lack of reliable information and flexible user demand sources.

IMF Shows Confidence in Tackling Down the Energy Crisis with Crypto-Backed "Green Funding"

According to IMF, funding with traditional green bonds is not as efficient because of all the levels of bureaucracy involved in it, which often takes months or even years to produce results. With the support of crypto tech, though, investors can obtain reliable information to make rapid decisions. The keys? Automation, rapid settlement, and unique digital unit that come with the tech. Compared with green bonds, crypto assets greatly improve efficiency. Besides, the tech can also verify renewable energy sources of power plants through equipped verifiable secure sensors and blockchain-based tracking systems, and manifest the information as one-time tokens. These tokens can serve as loan collateral in the DeFi environment, combined with programmable cryptocurrencies, stable coins, or central bank digital currencies (CBDCs), to provide investors with securities-like assets.

As the demand for decarbonized assets increases among governments and ESG-compliant companies, the model can create a deep capital market for climate action and reduce the financing costs of projects.

In addition, the IMF also explores the issue of renewable energy demand. The author proposes to use Bitcoin as a solution, because the mining is independent of geography and miners can work anywhere. Compared with other energy consumers, Bitcoin miners are happy to sweep up the leftover or redundant energy from any communities as long as the price is satisfactory, so the mining can be profitable and competitive. Therefore, miners are willing to become partners in renewable energy supply, making the power economy more predictable and feasible.

After all, whether we like it or not, cryptocurrencies such as Bitcoin have always been there, and will not disappear just because some government, or some organization loathes it for being wasteful, and comes up with a piece of ban. So, why not we guide them towards the renewable energy field instead?

Crypto Regulations to be Reconsidered While We Use Crypto to Aid Global Economy Recovery

Nonetheless, the crypto industry is flawed, particularly the speculations in the community have led to unrestricted leverage and fraudulent activities. Anonymity has made wash trading and other fraudulent activities more rampant. Therefore, clearer and more effective regulation is needed to address these problems.

Over the past year, the three main sources of financial risks in the crypto industry have been centralized financial services, such as the crypto lending platform Celsius, the crypto broker Voyager Digital​, and Three Arrows Capital. Another major crisis was Terra Luna's collapse​, which was essentially a Ponzi scheme under the guise of DeFi.

However, DeFi also poses other significant risks. Crypto security company Immunefi estimates that in the second quarter of 2022, losses due to smart contract exploits and hacker attacks amounted to $670 million. If DeFi is to attract more users, it needs to provide more reliable protection for their funds.

Therefore, regulators should demand more stringent requirements from managers of centralized financial services and consider them as brokers or other regulated financial entities. For the operation of DeFi, regulators should work with the community to establish self-regulatory solutions. For example, IMF suggests expanding "bug bounties" (rewards for identifying and fixing bugs) and conducting mandatory software audits on a regular basis, as well as stress testing leverage and collateral models more frequently.

In summary, all parties involved in both decentralized and centralized finance must first agree on the framework and common terminology before developing standards and rules.