Decentralized finance (DeFi) is an alternative form of finance offered by cryptocurrency platforms where investors can access readily available liquidity pools. As a bonus, there is no involvement from third-party lending institutions. Understandably, its popularity has seen an admirable increase.
With over $60 billion in value attached to DeFi projects as of April 2021, it has truly become a phenomenon. The same can be said with cryptocurrency, having caught the attention of various investors since Bitcoin’s launch over a decade ago.
Although DeFi and cryptocurrency have potential, it also raises queries surrounding novel policy and regulations. Financial regulations typically adopt the presence of intermediaries. Moreover, it applies regulation to intermediaries to oversee financial markets and relevant activities. Consequently, DeFi may put regulators and policymakers alike in uncharted – not to mention hostile – territory.
Potential risks and adapting
As DeFi projects grow, it has become obvious that they could display the risks that financial regulations are designed to address. Anti-fraud laws – like those that fall under federal securities and commodities laws – could draw attention to DeFi market fraud and manipulation. However, by scope, these authorities are quite narrow. They do not allow regulators to ensure proper monitoring of financial crimes, nor can they protect the consumer and financial stability in these markets.
Regulators will potentially need to step away from the beaten path. They should deliberate if they need extra authority to regulate these activities and effectively protect consumers. Market participants and developers of DeFi projects need to consider the broader policy and regulatory perspective while continuing their work.
Overall they should anticipate regulators taking an offbeat approach and not assess DeFi projects under the customs used for the previous influx of crypto projects. Additionally, DeFi market participants should ready themselves for the possible risk of retroactive regulation.
No need to rush
Barrelling through crypto regulation will trigger more harmful outcomes than good. With that said, a good start would be to have practical conversations.
The proposed language currently in the infrastructure bill being processed through Congress will likely lead to unforeseen consequences. Ones that may negatively impact the crypto space at a fundamental level. However, legislation is being deliberated at these levels is a step in the right direction, albeit a small one.
The proposed language unintentionally groups crypto exchanges – those that have largely improved reporting and disclosures during the past year or so – with a large collection of non-financial intermediaries. These include miners and network validators, as well as other third-party organizations. The most troublesome fact is that these organizations usually do not possess the information to file the necessary paperwork with the IRS or other policymakers.
Making improvements and boosting the coherency of crypto regulation would be a welcome development. However, rushing this process is definitely not a good idea.
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