The Future of DeFi: What It Means for Risk Managers

Decentralized finance (DeFi) may perhaps be best known as the engine behind cryptocurrencies – but it also has the potential to revolutionize finance by cutting out the intermediary for a range of financial services, including lending, borrowing and trading.

At the same time, this up-and-coming industry is rife with risks. In 2022 alone, the 10 largest DeFi attacks resulted in losses of $2.61 billion, and hacks, frauds and other types of scams have escalated significantly over the past decade.

What can the industry do to improve its reputation and to gain desperately needed investment funding? Moreover, what do FRM candidates and early-career risk managers need to know about DeFi, and what types of career opportunities does this innovative – but volatile – industry present?

What Is DeFi?

DeFi is a system that uses blockchain technology to create financial products and services that are not controlled by a central authority, such as a bank, government, or clearing exchange. Examples include lending and borrowing platforms, decentralized exchanges and stablecoins.

Cristian deRitis, Deputy Chief Economist, Moody's Analytics

One of DeFi’s key features is a lack of traditional regulation that banks and insurance companies face. According to Cristian deRitis, Deputy Chief Economist at Moody's Analytics, this freedom can help or hinder a company.

Since DeFi firms can’t share their risk management responsibilities with a regulator who will rescue them if things go poorly, their continued existence – and potential success – is dependent on prudent behavior. “Without a backstop from the Fed or FDIC, [DeFi] companies need to identify all risks and manage them properly if they intend to continue as an ongoing operation,” says deRitis.

On the flip side, this independence also makes DeFi firms vulnerable when there is a systemic shock beyond their control. Regulators are not going to save the day if there is a failure, notes deRitis, and it’s consequently imperative for businesses in this industry to build trust with their customers. “The FDIC guarantees bank deposits, which provides customers with a lot of confidence, because they don't have to research every bank to decide where to park their savings” he explains. “But DeFi firms don't have that guarantee, so customers may need some assurances that they are trustworthy.

Risk Managers to the Rescue?

Given the boom-or-bust nature of the industry, how can legitimate DeFi firms convince the public that they have sustainable business models and are not susceptible to hackers and other types of scammers who have previously defrauded the industry?

Education is vital, says deRitis, as is transparency. A DeFi firm, he elaborates, must be able to explain both how it’s different from competitors and what it does well. Following recent DeFi missteps, regular third-party audits and testimonials from satisfied customers might also prove helpful.

On the plus side for risk job seekers, deRitis thinks it’s inevitable that surviving DeFi firms will bulk up their hiring of risk managers. “Prudent risk management is necessary. Even if you get (DeFi) regulation — which currently appears unlikely — it will come with a healthy dose of risk management mandates,” he predicts.

How Risk Managers Should Approach DeFi Firms

For aspiring FRMs and early-career risk managers who are interested in DeFi, deRitis recommends highlighting a good mix of general skills – including problem-solving, communication, intellectual curiosity and foundational risk management. In addition, specialized knowledge related to DeFi can help set you apart from other candidates. “Having a deeper knowledge of how blockchain applications work or how the programming is done can certainly help distinguish you,” deRitis advises.

But he also warns aspirants not to overinvest in DeFi-specific skills. If you sink a lot of time and resources into becoming “hyper-specialized,” deRitis cautions, your investment might not bear any fruit – particularly if DeFi doesn’t gain enough traction over the next few years. The good news, though, is that you're probably ahead of most other candidates today if you have even a moderate DeFi understanding.

While deRitis encourages FRM candidates and junior risk managers to explore any fields that interest them, including DeFi, he also emphasizes that it’s critical to perform due diligence on potential employers. Indeed, it is especially important to avoid taking a first job with a disreputable firm. “Keep your eyes wide open,” deRitis counsels. “Your career can recover working for a failed company, but if you are put in a position where you appear to be involved in bad actions, that’s another matter.”

Tod Ginnis is a content specialist at GARP. He is the author of a GARP blog that is aimed at early-career risk managers and professionals aspiring to earn their Financial Risk Manager (FRM) certification.