17 July 2024
EEA has today released the DeFi Risk Assessment Guidelines, Version 1 https://entethalliance.org/specs/defi-risks/>. This groundbreaking document consolidates the risks associated with DeFi protocols and presents mitigation tactics. The guidelines also highlight the documentation and data that a project should provide to aid investors in evaluating and managing those risks and mitigations.
The standard has been created, and will be upheld, by the EEA’s DRAMA Working Group. This group has united leading representatives from the blockchain and financial sectors to strengthen the DeFi ecosystem against a variety of risks. Banco Santander, Bitwave, C4, Certik, Coinchange, Consensys, Cryptio, Cube.AI, DeFi Safety, DTCC, Entersoft, EY, Hacken, Noves, OpenZeppelin, QualitaX, Quantstamp, Relm, and SAP have combined their expertise and resources to produce this document.
Dyma Budorin, EEA DRAMA Co-Chair and Hacken CEO:
“The necessity for these Guidelines is underscored by the persistent regulatory ambiguity in the DeFi realm. As conventional frameworks fail to keep pace with the rapid expansion of DeFi, this document acts as a vital, industry-endorsed roadmap for navigating the intricacies of DeFi through focused risk management strategies.
From a security angle, adequate documentation is fundamental for the seamless operation and security of a project. This standard serves as the first all-encompassing resource that founders and development teams can depend on while developing their offerings.”
EEA DeFi Risk Assessment Guidelines Summary
This document is primarily intended for DeFi Protocol Users and Protocol Investors, but is also significant for Protocol Operators and Developers striving to reduce the risks in their Protocol. Furthermore, it can function as a reference for standard setters and regulators.
The Guidelines delineate the risks that may impact DeFi protocols, encompassing a multitude of areas such as software, governance, liquidity and tokenomics, external market influences, and compliance with regulations and standards. Subsequently, the paper discusses the data that can assist in evaluating the severity of each risk and delineates possible mitigation strategies that may be employed by the Protocols themselves, specialized service providers, or Investors.
The work encompasses diverse areas:
DeFi fundamentally relies on different types of Software. The Guidelines elaborate on issues affecting each category, such as Smart Contracts, Bridges, or Oracles. It also addresses challenges that can impact various software types, including the lack of standardization in DeFi, which can lead to interoperability hurdles and security vulnerabilities when integrating and normalizing software or data from varied suppliers or origins.
In addition to software, numerous factors play an essential role. The design of tokenomics and liquidity management intrinsic to each DeFi protocol, the organization’s governance frameworks, adherence to regulations and relevant standards, along with external market factors, can all introduce elements of risk for investors. From a straightforward governance flaw where a malevolent insider misappropriates funds intended for protection, to an external factor that affects a Protocol’s performance in the larger market, or legal challenges from regulators, the Guidelines offer insights on how to evaluate the probability of issues arising and provide strategies for minimizing the associated risks.
Chaals Nevile, EEA Director of Technical Programs and Editor of the EEA Defi Risk Assessment Guidelines:
“The creation of these guidelines has been, and remains, a collaborative initiative by EEA members, benefiting the industry and the wider ecosystem, as well as participating organizations. The diverse range of perspectives and expert knowledge that participants contribute has been pivotal to this effort. I am delighted to have been involved and proud to have been able to support the group, yet most importantly, I am thankful to everyone whose contributions and hard work made this possible.”
Utility of the DeFi Guidelines
For protocol creators and developers:
This serves as a reference manual for creating and managing a reliable Protocol: which documentation needs to be presented, what processes and workflows must be established to foster trust in the protocol, and how to approach topics like security, governance, tokenomics, liquidity, and external factors that may pose a risk.
For Regulators & Licensing
The DeFi Risk Assessment Guidelines can act as a reference point for regulators during the evaluation and licensing of projects. For instance, these Guidelines are already serving as a basis for the DLT assessment methodology in the recent collaboration between Abu Dhabi Global Markets and Hacken. Exchanges and other industry stakeholders are anticipated to embrace these guidelines, thus ensuring a robust and secure DeFi ecosystem.
For Institutional Investors
Institutional players will utilize the DeFi Risk Assessment Guidelines to identify and mitigate potential risks, fostering a safer and more dependable environment for decentralized finance activities. By adhering to these guidelines, institutional investors can better navigate the complexities of DeFi, contributing to, as well as reaping the benefits of, overall market stability and confidence.
Influence of DeFi Risk Guidelines on the ecosystem
The emergence of cryptocurrency exchange-traded funds (ETFs), including Ethereum ETFs, and the tokenization of assets highlight the necessity for a comprehensive risk assessment framework. Clear and standardized guidelines are vital as institutional investors pour into the crypto arena. Although the recent market upswing has drawn attention, it is the influx of these significant players that renders this standard essential. This framework helps ensure a secure and trustworthy atmosphere for all participants in decentralized finance.
Michael Lewellen, Head of Solutions Architecture at OpenZeppelin
“The DeFi sector is still swiftly evolving, accompanied by an ever-increasing array of new financial products and related challenges. There is a unique blend of financial and technical risks that newcomers to the market must account for. The EEA DeFi Risk Assessment Guidelines provide a detailed overview of both financial and technical risks and will be indispensable for businesses and institutions wishing to engage safely in the DeFi ecosystem.”
About EEA
The EEA represents a global collective of blockchain leaders, adopters, innovators, developers, and enterprises. We are propelling business in Ethereum through professional and commercial support, advocacy and research, standards formulation, and ecosystem trust solutions.
The EEA is acknowledged for creating and upholding the leading industry standard for smart contract evaluation, its EthTrust Security Levels specification. Crafted by specialists from several firms, it expanded early foundational work, such as the SWC registry and the security initiatives of the Solidity language project to enhance smart contract security practices.
For additional details regarding the EEA’s DeFi Risk Assessment Guidelines or its Working Groups, please reach out to EEA’s Technical Program Director Chaals Nevile: [email protected].
For inquiries about EEA membership, please contact [email protected] or visit https://entethalliance.org/become-a-member/