17 July 2024
The EEA has officially released the DeFi Risk Assessment Guidelines, Version 1 <https://entethalliance.org/specs/defi-risks/>. This groundbreaking document consolidates various risks associated with DeFi protocols, along with suggested mitigation strategies. It also emphasizes the documentation and data that a project should make accessible to enable investors to evaluate and manage those risks effectively.
This standard has been developed and will continue to be updated by the EEA’s DRAMA Working Group, which includes leading representatives from the blockchain and financial sectors to strengthen the DeFi ecosystem against a wide array of risks. Organizations such as 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 create this important document.
Dyma Budorin, Co-Chair of EEA DRAMA and CEO of Hacken:
“The necessity for these Guidelines is underscored by the ongoing regulatory ambiguity in the DeFi sector. Given that traditional frameworks are not keeping pace with DeFi’s swift evolution, this document provides a crucial, industry-endorsed guide for navigating the complexities of DeFi through strategic risk management.
From a security standpoint, proper documentation is essential for the seamless operation and safety of a project. This standard represents the first comprehensive resource that founders and development teams can rely on as they work on their products.”
Overview of EEA DeFi Risk Assessment Guidelines
This document is primarily aimed at DeFi Protocol Users and Protocol Investors, but it is also applicable to Protocol Operators and Developers seeking ways to minimize risks within their Protocol. Additionally, it can serve as a useful tool for standard setters and regulators.
The Guidelines outline the risks that may impact DeFi protocols, encompassing areas such as software, governance, liquidity and tokenomics, external market influences, and regulatory compliance. The document discusses the information that can assist in evaluating the degree of each risk and presents potential mitigation strategies which can be utilized by the Protocols themselves, third-party service providers, or Investors.
The work touches on various aspects:
DeFi relies fundamentally on multiple types of Software. The Guidelines identify challenges affecting each type, including Smart Contracts, Bridges, or Oracles. It also addresses broader software-related issues, such as the lack of standardization in DeFi, which can lead to interoperability challenges and security vulnerabilities when integrating and normalizing software or data from diverse suppliers.
Beyond software-related issues, several other factors are critical. The design of tokenomics and management of liquidity for each DeFi protocol, governance frameworks, adherence to regulations and relevant standards, and external market factors can all present risks for investors. The Guidelines offer insights on assessing the likelihood of potential issues arising and provide strategies for mitigating associated risks, ranging from a governance failure caused by a malicious insider to external market impacts or legal challenges posed by regulators.
Chaals Nevile, EEA Director of Technical Programs and Editor of the EEA DeFi Risk Assessment Guidelines:
“The development of these guidelines has been, and remains, a collaborative initiative of the EEA members, aimed at benefitting the industry and the broader ecosystem, as well as the participating organizations. The diverse perspectives and deep expertise that participants contribute have been essential to this effort. I am pleased to have contributed and proud to support the group, and I am immensely grateful to everyone whose hard work and input made this possible.”
Benefits of the DeFi Guidelines
For Protocol Founders and Developers:
This is an essential guide for developing and managing a reliable Protocol. It details what documentation must be provided, what processes and workflows should be established to ensure trust in the protocol, and how to address concerns related to security, governance, tokenomics, liquidity, and external risks.
For Regulators & Licensing
The DeFi Risk Assessment Guidelines can serve as a foundational resource for regulators assessing and licensing projects. For instance, the Guidelines have already been adopted as a basis for the DLT assessment methodology in the recent collaboration between Abu Dhabi Global Markets and Hacken. Exchanges and other industry participants are expected to implement these guidelines, fostering a robust and secure DeFi ecosystem.
For Institutional Investors
Institutional players can utilize the DeFi Risk Assessment Guidelines to identify and address potential risks, creating a more secure and trustworthy environment for their decentralized finance activities. By adhering to these guidelines, institutional investors can better navigate the complexities of DeFi, thus contributing to and benefiting from enhanced market stability and confidence.
Influence of DeFi Risk Guidelines on the Ecosystem
The emergence of cryptocurrency exchange-traded funds (ETFs), including Ethereum ETFs, alongside asset tokenization emphasizes the necessity for a comprehensive risk assessment framework. As institutional investors begin to enter the crypto landscape en masse, having clear and standardized guidelines is crucial. The current bull market, while drawing attention, underscores the importance of these major players, making the establishment of this standard imperative. This framework aims to provide a secure and trustworthy environment for all participants involved in decentralized finance.
Michael Lewellen, Head of Solutions Architecture at OpenZeppelin:
“The DeFi sector is evolving quickly, presenting an expanding array of new financial products along with associated challenges. There exists a unique blend of financial and technical risks that must be considered by newcomers to the market. The EEA DeFi Risk Assessment Guidelines offer a comprehensive overview of both financial and technical risks and are essential reading for businesses and institutions wishing to safely engage in the DeFi ecosystem.”
About EEA
The EEA is an international community comprising blockchain leaders, adopters, innovators, developers, and businesses. Our mission is to drive business innovation in Ethereum through professional and commercial support, advocacy and research, standards development, and ecosystem trust services.
The EEA is recognized for establishing and maintaining the leading industry standard for smart contract evaluation, known as the EthTrust Security Levels specification. Developed by experts from various companies, it builds on earlier foundational work such as the SWC registry and the security initiatives of the Solidity language project to enhance smart contract security practices.
For additional information 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 related to EEA membership, please contact [email protected] or visit https://entethalliance.org/become-a-member/
