Who, what and how to regulate in a world without borders and governed by codes?
Hold on to your hats, boys and girls! It’s a new world – a financial system without intermediaries, which anyone can access 24 hours a day with just a cell phone and a wallet! As Julien Bouteloup told me:
“In DeFi, what we’re building is fully decentralized, fully transparent technology driven by math. No one can beat that.
He continued, “We draw on research papers, 40 years of research, basic research, discrete math being built and chaining that no one can beat. You can’t beat that. GitHub didn’t exist in the 90s. First, the fact that we are going at lightning speed is because everything is open source and anyone can participate.
Related: DeFi Literacy: Universities Adopt Decentralized Financial Education
A Novum Insights report in August indicated that since 2020 the DeFi market has grown by a factor of 40, with the total value stuck in DeFi standing at around $ 61 billion at the time (while the current TVL has grown by a factor of 40). amounts to around $ 165 billion). The capitalization of Stablecoins, a significant part of DeFi, increased in the first half of 2021 to reach $ 112 billion.
Massive gains are being made but at the same time DeFi investors are also losing money because DeFi is not regulated, moderated, brokered, hosted or validated by a central authority, only driven by smart contracts. So if a smart contract fails or is attacked, consumers have no recourse. Loretta Joseph, global expert in digital asset regulation, told me, “Regulators protect consumers and investors. In DeFi, you don’t have any intermediaries to regulate, so it’s totally P2P. The question is how this will be regulated in the future. People are going to get ripped off. When people start to get ripped off, the first thing they do is complain to the regulator. “
Related: Will regulation adapt to crypto, or crypto to regulation? Expert response
Indeed, since 2019, DeFi protocols have lost around $ 285 million due to hacks and other exploit attacks. And as the experts said, the majority of hacks were due to developer incompetence and coding errors. This is important when the industry is completely code dependent.
Related: The radical need to update blockchain security protocols
The challenges of regulation
Hester Peirce, of the United States Securities and Exchange Commission, said in an interview with Forkast.News about DeFi in February: “This is going to be a challenge for us because most of our regulations go through intermediaries, and when you really build something decentralized, there is no middleman. This is excellent for the resilience of a system. But it’s a lot harder for us when we’re trying to get in and regulate to figure out how to do that. “
Regulatory concerns tend to revolve around the volatility of crypto markets as opposed to government backed fiat currency, the risk of money laundering and terrorist financing, the unregulated nature of the market and the lack of remedies for financial losses. Non-fungible tokens explode, generating excitement, confusion, legal questions, and massive payouts. NFT markets also attract large crypto transactions, which will likely annoy regulators, who might view large movements of money in NFTs as money laundering. At the macro level, the decentralization of the financial system and the ability to manage economic stability and protect the interests of consumers pose an additional challenge for regulators.
Related: Legal non-fungible tokens
DeFi Decentralized Autonomous Organizations (DAOs) are popular as a way to transfer cryptocurrencies between different blockchains. This supports crypto lending and yield farming. DAOs, conservatively estimated, oversee more than $ 543 million. In a DAO, IT governance and corporate governance are one and the same. The organization is governed and operated by smart contracts, which are monitored and enforced by algorithms. Code governs and executes. If the algorithms fail, then who is responsible?
In a joint article titled “Regulating Blockchain, DLT and Smart Contracts: a technology Regulator’s perspective,” a group of researchers present some key points to consider: (1) the importance of identifying focal points that can be used to apply the regulations to, such as miners, basic software developers, end users. They even raise the potential for government or regulatory actors to be potential participants; (2) liability identification issues – could major software developers be held liable? ; (3) challenges related to the immutability and lack of capacity to update smart contracts; and (4) the need for quality assurance and technology audit processes.
Exchanges and portfolio providers are expected to be a priority for regulators. Decentralized exchanges allow users to exchange directly from their wallet in a P2P manner without intermediaries. The global money laundering watchdog, the Financial Action Task Force (FATF), has talks in store. Christopher Harding, Civic’s Chief Compliance Officer, noted that the FATF is proposing guidelines suggesting that DApps will need to comply with country-specific laws applying FATF, AML, and counter-terrorism financing requirements. .
Related: The draft FATF guidelines target DeFi with compliance
A recent review of 16 leading exchange platforms by the London School of Economics and Political Science found that only four were subject to a significant level of trading-related regulation, so there is an obvious gap. To be listed on any major exchange now requires a project to pass the audit, but meaningful security doesn’t end there. Toby Lewis, CEO of Novum Insights, noted:
“Also remember that smart contracts can be attacked. Even if they are audited, that does not guarantee that they will be without achievement. Do your own research before you start.
In an open source environment where projects are growing at an average compound growth rate of 20% per year, finding the right time to regulate, in which people are protected from risk but innovation is not constrained, is a challenge. classic problem to be solved. Some governments have sought to achieve this balance using regulatory sandboxes (UK, Bermuda, India, South Korea, Mauritius, Australia, Papua New Guinea and Singapore), while others have gone directly to legislate (San Marino, Bermuda, Malta, Liechtenstein).
Far from resisting regulation, leading DeFi personalities are embracing it as the industry matures. In an interview with Cointelegraph, Stani Kulechov, the founder of the DeFi Aave lending platform, suggests that peer review will be the future: “Auditors are not there to ensure the security of a protocol, they help. simply to spot something that the team itself was not aware of. Ultimately this is a peer review and we as a community need to find incentives to empower more security experts in space. In the same article, Emeliano Bonassi spoke about ReviewsDAO, a peer review forum for connecting security experts with projects looking for reviews. Bonassi sees the potential for this to become a learning opportunity where people with specialist knowledge can help improve ecosystem security.
Tan Tran, CEO of Vemanti Group, suggested, “Going forward, I see accelerated adoption of platforms with unlicensed financial products and services that can be used by anyone anywhere, but anyone. will be governed by a regulated party with centralized control to ensure accountability and compliance. It’s not about stopping innovation. Rather, it is about deterring bad actors from exploiting unsuspecting consumers. Giving an expert opinion on DeFi to Cointelegraph, Brendan Blumer, CEO of Block.one, concluded: “The real winners in the digital economy will be those who think long term and take the time to ensure that their products meet the requirements of legal and professional services. . ”
It certainly looks like stock exchanges and software developers could be in the crosshairs of regulators. We anticipate that regulators will look for ways to improve technology quality assurance processes and DeFi governance, which can only be done in collaboration with industry. Mark Taylor stressed that regulators must continue to work in partnership with players in the crypto industry to protect consumers.
Julien Bouteluop explained: “We are in fact building, in DeFi, everything that traditional finance has, but faster, stronger, more transparent and accessible to all those who are here. It really is different. This means that anyone in the world can access the technology and does not need to ask permission from anyone. I think it is necessary to push for innovation and to build a better world.
Who, what and how do we regulate in this 24/7 global borderless market? It’s a whole new ball game. Regulators and industry will have to work hand in hand.
The views, thoughts and opinions expressed here are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Jane thomason is a thought leader on blockchain for social impact. She holds a doctorate. from the University of Queensland. She has held several positions with the British Blockchain & Frontier Technologies Association, Kerala Blockchain Academy, Africa Blockchain Center, UCL Center for Blockchain Technologies, Frontiers in Blockchain and Fintech Diversity Radar. She has written several books and articles on Blockchain. She has been featured in the Crypto Curry Club’s Top 100 Women in Crypto, the Decade of Women Collaboratory’s Top 10 Digital Frontier Women, Lattice’s Top 100 Fintech Influencers for SDGs and Thinkers’ Top 50 Global Thought Leaders and Influencers on Blockchain360 .