Community-Driven Finance Unveiling the Dynamics of DeFi Governance

Introduction

The decentralized digital ledger system known as blockchain technology has completely changed how transactions are recorded and validated over networks. Due to its association with cryptocurrencies like Bitcoin, the concept of blockchain was first made famous (Lewis 2018). However, in the intervening years, it has developed into a flexible technology that could find application in a wide range of sectors. Its dispersed structure eliminates the need for “middlemen.” Because of the stability of blockchain, once an operation is put to the register, it cannot be removed, keeping the system secure. Blockchain networks ensure the integrity and security of transactions by preventing tampering and granting non-access through the use of cryptographic techniques (Lewis 2018).

Blockchain serves as the underlying infrastructure that enables the functioning of decentralized financial systems. DeFi (Decentralized Finance) is emerging as a significant development in global finance alongside FinTech, RegTech, cryptocurrencies, and digital assets. DeFi aims for decentralization in financial services, challenging traditional centralized models. DeFi is characterized by a mix of technologies including AI, blockchain, cloud computing, and big data, driving its decentralization efforts. DeFi challenges state-based legal systems by seeking full decentralization, undermining traditional jurisdiction and applicable law. DeFi's reliance on technology increases security risks and connectivity vulnerabilities, potentially leading to cyberattacks and operational difficulties. Addressing tech risks in DeFi requires international collaboration among regulators to assess system weaknesses and liability assignments (Zetzsche, Arner, and Buckley 2020; Chohan 2021; Salami 2021; Jensen, von Wachter, and Ross 2021).

DeFi governance is the process of optimizing the DeFi system from both economic and technical perspectives, considering vulnerabilities and real-world attacks. Decentralized governance in DeFi involves smart contracts, blockchain technology, and decentralized decision-making (Weingärtner et al. 2023). DeFi governance involves Decentralized Autonomous Organizations (DAOs) implemented via governance protocols, where users are given governance tokens granting them voting rights (Dotan et al. 2023). DeFi governance involves smart contract governance, which includes addressing issues like flash loan attacks and reentrancy attacks in DeFi applications (Ma et al. 2023). Decentralized finance (DeFi) enables financial intermediation in new ways, but also poses risks from underlying technologies that can facilitate illegal behavior and hamper authorities' supervision (Grassi et al. 2022).

Against this backdrop, the primary objective of this chapter is to explore the DeFI governance in the context of community-driven governance. The chapter also provides insights into challenges and considerations regarding community-driven DeFi governance. To achieve this objective, the chapter aims to answer the following research questions:

• 1.

  What is DeFI governance and how it is related to community-driven governance?

• 2.

  What are the potential challenges associated with community-driven DefI governance, and how can these challenges be mitigated?

• 3.

  What future of DeFi governance?

In the pursuit of answers to the research questions, this chapter is structured as follows: First, the concepts of DeFi Governance are presented. The second section describes community-driven governance with some key examples such as Uniswap, MakerDAO, Aave, and many more. The challenges associated with community-driven DeFI governance are explored in section four. The subsequent section provided a discussion on the future of DeFi. Finally, conclusions are drawn in the last section.