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Regulator Scrutiny: How Can We Support DeFi’s Sustainability?


www.financemagnates.com 21 June 2022 12:34, UTC
Reading time: ~3 m

DeFi services and financial products are based on transparency: anyone can look at product data and examine how the system works. In exchange for this transparency, these services can provide access to decentralized trades and assets. They are open to anyone with internet access and are largely owned and maintained by their users.

1.7 billion adults in the world remain unbanked, according to the World Bank's 2017 Findex report. Often without access to reliable currency and a robust banking system, unable to send remittances, these people find themselves cut off from many economic tools. DeFi offers a game-changing opportunity to put financial instruments in the hands of anyone with a smartphone in their pocket.

Nowadays, the legal framework governing DeFi is still patchy. The protocols are largely unregulated, which presents concerns about criminal activity and money laundering. Market volatility and the lack of clear tax mechanisms are also, in a way, deterrents for investor and user confidence. Regulatory risks are often significant as the reach of DeFi is global; transactions are generally anonymous; and there are no (mostly) identified intermediaries. And, in the end, because of the decentralized structure, it is not easy to introduce regulations for DeFi that would become accepted globally.

Is It Possible to Regulate DeFi?

While clear regulations and procedures are more likely than not to emerge, you should not expect this to happen overnight. In the United States, for example, different aspects of DeFi fall under the jurisdiction of different state agencies. Many other countries have a similar 'patchy' situation in the regulation of the DeFi sector.

But, as the interest of regulators grows in line with market growth, the regulations that can reap the crop without killing the soil will finally be accepted, creating a more hospitable environment for investors and crypto innovators.

It is also not unlikely for a (very, very) small share of the regulation to be delegated directly to DeFi participants. Even if it does happen, the delegation of control levers to market participants is a step-by-step process.

In What Way Can Regulations Affect the Space?

It could very well be that we soon see a market fractionated into those willing to work with regulators and the 'rogues'. Polarization between high-risk projects in DeFi offering potentially huge benefits, and those who have entered the regulatory field and began to play by the accepted rules, will remain.

Both segments will undoubtedly have demand, but over a long enough term, it’s only natural to see the large capital flows entering regulated platforms. And, many projects already state that they want to work within DeFi as a compliance requirement of the regulators.

Minimizing Consumer Risk without Introducing Regulations

High risk always goes hand in hand with the potential for high gains.

DeFi is fundamentally an investment. And yes, investing involves speculative risks. Whether it's hoping for a rise in token prices, betting one's capital on an attractive asset, or some other investment framework.

If investments are entirely outside regulatory oversight, of course, such markets are riskier than traditional ones, where participants tend to play by the same long-established rules. Hence, although insurance or regulation could potentially reduce risks, it will also decrease the interest one can get in the market.

Nevertheless, due to the decentralized nature of the market, there is no reason to believe that regulations will be truly decisive in curbing asset volatility or risks in DeFi.

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