Decentralized Finance (DeFi) is becoming one of the most important sectors within the blockchain industry. In the past two years alone, the Total Locked Value (TVL) in DeFi (the total value of assets stored on various DeFi platforms) has grown steadily, from $ 21 billion at the beginning of the year to $ 100 billion today.
DeFi represents a wide range of financial products and services, including the very popular decentralized exchanges (DEX). Nevertheless, Despite the explosive growth of DeFi credit and credit products, insurance and even decentralized derivatives trading, global regulation still seems a long way off.
Through DeFi, blockchain technology is reshaping the world’s financial systems and building markets that are ideally safer, more transparent and more accessible. Financial innovations are quite intuitive and profitable, but institutions with more resources are still reluctant to enter this area due to a lack of regulation and this could play a crucial role in its adoption.
Some believe that regulatory compliance is the only way forward and that while regulation could centralize certain aspects of DeFi, projects that comply will survive in the long run. Others argue that DeFi should self-regulate and that the community should agree on what is best for their future. In any case, there will always be unregulated platforms out of control by the authorities, but it remains to be seen whether large-scale self-regulation would be really healthy for the industry.
Despite the fact that many mid-cap funds generate gigantic returns from investing in digital assets, the largest hedge funds are unwilling to take the risk. This is partly due to the rigorous scrutiny under which key players are monitored for compliance, and it could also explain why some of the larger institutions haven’t touched this asset class yet.
Control the uncontrollable
The main problem with applying traditional regulatory frameworks to decentralized funding is that they have been designed with different objectives. Traditional finance favors stability, investor protection, enforcement and, above all, centralization. DeFi works with a system that encourages collaboration between distributed participants by removing financial incentives, and without central intermediaries, traditional frameworks don’t translate well into decentralized assets.
In recent years, the effects of regulation in the cryptocurrency sector have been evident, providing private investors with a sense of security, increasing capital inflows into digital asset markets, while supporting innovation and stopping fraudulent and illegal behavior. This could be true of DeFi as well, and while not everyone is totally convinced, familiarity and education can be big drivers of adoption.
A former police officer of the Department of Illegal Finance and Crime Proceedings of the US Department of Homeland Security and Chief Operating Officer of Huobi Nevada, Robert Whitaker, said Cointelegraph:
“There will always be illegal sites operating in the background. DeFi platforms that want to be regulated and believe that regulation is the path to a solid viable alternative to traditional banking or finance will survive, and in my opinion they will do very well. ” . “
Once the necessary infrastructure is in place to meet the needs of the largest institutions, DeFi investments could even be much more experimental to accelerate innovation. This year alone, several financial services giants have made significant strides in the blockchain arena.
People say that JPMorgan is developing its own blockchain with its own token to enable its customers to make instant transfers. After plans were forged to move more than a third of eligible assets to a blockchain-based escrow platform, HSBC announced earlier this year that it will support central bank-issued digital currencies (CBDCs) through regulation. Morgan Stanley also recently announced that it will offer its clients exposure to digital assets.
From BNY Mellon’s confirmation that it supports digital asset custody, to disclosing its behind-the-scenes interactions with BlackRock’s investigation into this asset class, adoption is sure to grow. The question is: Can regulation keep up?
Innovative rules for regulating innovation
Recently the leader in blockchain technology solutions ConsenSys has received more than $ 65 million in funding from global financial services companies including UBS, JPMorgan and Mastercard, This could give you a better idea of the types of applications that are built on Web 3.0.
According to PWC reports, nearly 50% of traditional hedge fund managers are considering investing in cryptocurrencies. While these companies are likely to lead the way to adoption, it may not be able to do so until the required regulatory infrastructure is in place in the DeFi ecosystem.
Despite countless warnings from reserve banks around the world about the security, scalability, and money laundering risks posed by digital assets, most of them agree that they can radically improve the financial system. The US Securities and Exchange Commission, however, believes that DeFi is seriously lacking in investor protection and is calling for additional authorities to be created to prevent DeFi products and platforms from sneaking into the markets.
The past year has been riddled with news from international companies and national regulators working towards a better understanding of blockchain technology. In September 2020, the European Commission proposed a framework to improve consumer protection and set more explicit behavior for cryptocurrency players, including introducing new licensing requirements.
Later in March The Financial Action Task Force (FATF), the regulator for the financing of terrorism and money laundering, announced that it will update its guidelines on a risk-based approach to digital assets and the companies speculating on them. In July, The Japanese Financial Services Agency (FSA) highlighted the importance of regulatory standards for decentralized finance.
Already in February, SEC Commissioner Hester Pierce said regulators needed to provide the DeFi space with both legal clarity and freedom to experiment so that it could compete with centralized alternatives from you to you. However, the SEC has also taken action against certain entities related to decentralized financial applications.
For example, news reports suggest that The regulator has launched an investigation into the leading developer behind the world’s largest decentralized exchange, Uniswap Labs. primarily focus on how investors use and market the platform. Additionally, SEC chairman Gary Gensler recently made some harsh comments about the DeFi industry. that only a small number of DeFi tokens are not securities.
While self-regulation may seem ideal to some, government and financial agency intervention may be inevitable.
Twist the principles
The main challenge facing regulators will be to insure private actors and mitigate risks for investors. If legislation can somehow do this while at the same time ensuring that DeFi platforms adhere to anti-money laundering protocols, regulation could encourage adoption and create incredible growth for the space in a risk-controlled manner. .
Still, the violent regulation of DeFi protocols may not be the best way to go. Traditional rules apply to transactions that take place between people, and applying these rules to human-written code, that is, to smart contracts, is a very difficult task. However, standards could be drawn up according to codified principles.
This would require the establishment of capital limits and risk control frameworks for private actors in the sector. However, since this runs counter to the main ethics of decentralized finance (decentralization), it requires a proactive and collaborative approach from the DeFi space and a mindset from regulators with an innovation priority.