• The Bank for International Settlements, an umbrella group for central banks, says it’s concerned there’s a “decentralization illusion” in DeFi.
• DeFi is a fast-growing part of the cryptocurrency market that promises traditional financial goods without the involvement of middlemen like banks.
• Regulators are increasingly concerned about platforms offering DeFi services that may not be as “decentralized” as advertised.

The central bank of central banks is worried about “decentralized finance.”

In a paper released this week, the Bank for International Settlements, an umbrella group for central banks, that it’s concerned there’s a “decentralization illusion” in DeFi.

DeFi is a fast-growing part of the cryptocurrency market that promises to deliver traditional financial products such as loans and savings accounts without involvement from regulated middlemen like banks.

Regulators, on the other hand, are growing concerned about platforms that offer DeFi services that may not be as "decentralised" as they advertise.

"What we found is that, first and foremost, the decentralised part tends to be elusive," Agustn Carstens, the BIS's general manager, told CNBC's Julianna Tatelbaum Tuesday.

"There are certain incentive concerns relating to the fact that, as a result of this decentralisation,  at some point you end up with some agents that play an significant role, and not necessarily for the best [interests] of financial service users."

The central bank group did not mention any specific names related to its concerns.

The BIS said DeFi must be “properly regulated” in order to safeguard investors and boost trust in the market.

Timo Lehes, a co-founder of Swarm Markets, a decentralised crypto exchange, acknowledged that there was still work to be done in DeFi, but stated that several institutions in the area are actively trying to address the systemic challenges raised by the BIS.

“Ultimately, each protocol will face the decision of whether to transition to a compliant business model,” Lehes wrote in an emailed note on Tuesday.

“There’s much to gain from operating within regulatory frameworks established to protect investors and maintain access to markets.”

Many DeFi services are built on top of Ethereum, the blockchain network behind ether, the world’s second-biggest cryptocurrency. Transactions are facilitated through so-called smart contracts, which automate various processes through lines of code.

More than $100 billion worth of funds is currently sitting on Ethereum-based DeFi protocols, according to data from crypto news and research firm The Block. Some of the biggest platforms in the space include Maker, Curve and Compound.

The promise of high returns on loans and savings is luring investors to DeFi sites. However, hackers and fraudsters are increasingly being targeting them. According to blockchain analytics startup Elliptic, DeFi frauds and thefts have cost over $10 billion so far in 2021.

The BIS said it believes the risks around DeFi have currently been contained to crypto markets but that, going forward, “the growth of DeFi poses financial stability concerns.”

The group flagged “severe” vulnerabilities with the industry, including highly-leveraged trades, liquidity issues and a lack of shock absorbers such as banks.

“It’s important that we as authorities don’t feel complacent,” Carstens said. “There might be aspects that are safe but there are also some aspects that are not, and I think that should make us think seriously about it.”