## ‘DeFi’ and ‘TradFi’ Must Work Together

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**Canonical URL:** [‘DeFi’ and ‘TradFi’ Must Work Together](https://www.imf.org/-/media/files/publications/fandd/article/2022/september/casey.pdf)

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### Context and overview
- The cryptocurrency industry is experiencing a crypto winter: tokens like bitcoin and Ethereum’s ether have lost three-quarters of their value and major crypto lending and investing firms have collapsed into bankruptcy.
- Traditional finance faces severe stresses: the highest inflation in 40 years, a war that has fractured the international monetary system, an energy and commodity crisis, and record temperatures exposing investment shortfalls for climate change mitigation.
- Thesis: DeFi and TradFi must integrate strengths—DeFi’s financial innovation and TradFi’s regulatory and institutional stability—to fund renewable energy and address broader systemic vulnerabilities.

### Centralization problems motivating decentralization
- Centralization examples cited:
  - Negotiations with a single unelected actor (Saudi Crown Prince Mohammed bin Salman) to boost oil production during a global energy crisis.
  - Germany’s dependence on Russian natural gas constraining sanctions.
  - The Colonial pipeline shutdown affecting 60 million people.
  - 2017 Hurricane Maria causing 90 percent of Puerto Ricans to lose power for months after a few transmission lines failed.
- Argument: These vulnerabilities stem from lack of redundancy and motivate decentralized renewable energy deployment (solar, geothermal, wind, recycling of waste heat).

### Green funding potential via DeFi and crypto technologies
- Funding shortfall:
  - The Climate Policy Initiative estimates world investment in addressing climate change was $632 billion in 2019–20, versus $4.5–$5 trillion needed annually to achieve net zero carbon emissions by 2050.
- Two principal barriers to renewable deployment:
  - Lack of reliable, rapidly actionable information to measure and project outcomes.
  - Lack of persistent, flexible user demand to make production economically viable.
- How crypto/DeFi can help:
  - Blockchain-enabled sensors and tracking can verify renewable power generation and immediately represent that information as unique one-off tokens.
  - These tokens can become collateral for lenders in a DeFi environment, incorporating programmable cryptocurrencies, stablecoins, or central bank digital currencies to give investors remote security.
  - Increased demand from governments and ESG-compliant companies for proven carbon-reducing assets could create deep liquidity around tokenized renewable assets, driving down financing costs.
- Example scenario:
  - A remote Rwandan community builds a DeFi-funded solar microgrid to power a new irrigation system.

### Bitcoin mining as a demand sink for excess renewable energy
- Economic coordination problem:
  - A solar microgrid may need 2 megawatts to be financially viable, while a community irrigation system requires only 500 kilowatts.
- Bitcoin miners as geographically-agnostic energy consumers:
  - Miners will operate anywhere and absorb excess or wasted energy if it is priced low enough to be profitable.
  - Renewable energy is the cheapest form of energy and thus attractive to miners.
  - According to the Cambridge Center for Alternative Finance, 53 percent of the Bitcoin network runs on renewable energy.
  - Bitcoin network consumption (midrange estimate): around 84 terawatt hours annually, about 0.38 percent of total world consumption.
- Market dynamics and recent trends:
  - Bitcoin prices have plunged (three-quarters loss noted), and Intel’s new Blockscale ASICs are expected to create a glut of cheap chips, making low-cost energy the primary factor for miner expansion.
  - Mining often relocates after bans (example: 2021 ban in China prompted migration to the United States, Kazakhstan, and others).
- Policy and development recommendations:
  - If Bitcoin cannot be regulated out of existence, steer mining toward renewable sources by removing subsidies for dirty power and enticing miners to provide long-term funding commitments to renewable providers with minimum capacity thresholds for communities.
  - Encourage partnerships between miners and community-based solar microgrids to spread wealth and generation capacity, avoiding centralized state capture (contrast with El Salvador’s government mining at a state-owned geothermal plant and retaining proceeds).

### Risks in crypto and regulatory framework suggestions
- Recent contagion and failures:
  - Major centralized failures: Celsius, Voyager Digital, Three Arrows Capital.
  - Terra Luna characterized as a de facto Ponzi scheme; it was DeFi in name only.
  - Real DeFi projects such as Aave and Compound have so far survived stress.
- Security losses:
  - Crypto security firm Immunefi estimates $670 million lost in Q2 2022 from smart contract breaches and hacks.
- Regulatory approach proposed:
  - Impose stricter fiduciary requirements on managers of centralized “CeFi” services—treat them like brokerages or other regulated financial institutions.
  - For DeFi operations, avoid imposing outdated centralized regulatory models that make leaderless open-source developer groups accountable inappropriately.
  - Develop self-regulatory solutions in collaboration with the industry that leverage technological strengths and decentralized structures, including:
    - Expanding “bug bounties” that reward developers who identify and fix incidents.
    - Mandating periodic software audits.
    - Conducting frequent stress tests of leverage and collateral models.
  - Establish consensus on what constitutes a decentralized system and whether projects aspiring to decentralization are appropriately evolving toward it.
  - All stakeholders from DeFi and TradFi must agree on frameworks and a common lexicon, then establish standards and rules.

*Michael Casey, chief content officer of CoinDesk — Finance & Development, September 2022*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/september/casey.pdf_