DeFi: to regulate or not to regulate?

While the coming years will decide whether decentralised finance (DeFi) manages to cross the chasm into mainstream adoption, a panel discussion tackled the issue of how regulators should approach the sector—and to what extent the old rules can apply to this new turf.

“Some people view regulation as a way of minimising the risks of DeFi and legitimising it in the eyes of the investors. Others believe that DeFi is better off self-regulated,” Lambis Dionysopoulos, a fintech and crypto researcher at the University of Nicosia, said at the EU Blockchain Summit on Friday.

“Is this the right time to regulate DeFi, or should we give the industry some time to develop, and perhaps even come up with its own mechanism for self- regulation?”

DeFi has come to represent a large industry covering a wide variety of different types of financial instruments and services – such as decentralised exchanges, decentralised money markets, or decentralised insurance companies. However, at the present stage it remains broadly unregulated by the global official sector.

“There’s a common misconception that ‘Nobody is in charge,’ when it comes to decentralised finance,” said Merav Ozair, a financial instruments strategist and member of the International Association for Trusted Blockchain Applications (INATBA).

“In reality, there is governance. It is just different: it’s self-governance. Self-regulation is necessary to survival, and the community knows this. So, there are rules and policies that the members of the community must abide by,” she said.

Magnus Jones, Nordic blockchain & innovation lead at Ernst & Young, argued that times aren’t ripe for regulations. “Personally, I think this is not the time for regulators to go in and begin to regulate. It is the time for them to go in and try to understand it.”

“It’s much easier for anybody to understand this new thing right now before the landscape becomes devilishly complicated.”

DeFi doesn’t entail any intermediaries to regulate, noted Nathan Vandy, INATBA governance co-chair. “Nonetheless, the question remains: Does the industry need regulation, or is it functioning well on its own?”

Jan Klesla, co-founder of Blockchain Republic and aviser at the technical group of the European Commission’s European Blockchain Partnership, said it’s up to the sector to prove that it doesn’t require burdensome regulations.

“To avert this, we have to prove to regulators and to the market that we deserve to be left alone. Now is the time to prove to them that self-regulation can be more efficient that traditional regulation.”

Vandy argued setting up a regulatory sandbox would be the best approach. “In the US, [SEC commissioners] proposed an arrangement of working for a few years in collaboration with regulators, to make sure that the protocols and operations are in line with best practices. And then to gradually decentralise afterwards,” he said.

“I think more collaboration, at least initially, might be the right way to go.”

Klesla said: “I think it’s not just about DeFi aligning with the regulations, but also regulations aligning with DeFi. We all believe that DeFi is the future of finance. This is the next evolutionary step, without intermediaries.

“Maybe not all financial services will be decentralised. But I believe we are witnessing the death of intermediaries in financial services after […] five or six hundred years. The whole of financial regulation needs to align itself to the next evolutionary stage.”

However, Ozair pointed out that letting the market do what it wants “and have regulators sit back and look” is probably not a realistic option.

“This will lead to regulators always having to intervene,” she said. “Then, we have to comply – or, if not complying, ending up being suspended. And going back and forth.

“We have to act together, as regulators and industry, to build an application that makes sense to use, that is compliant – to see that regulators can monitor in a better way than they do monitor today the traditional markets.”

“We need to tell regulators ‘Come work with us. Help us build this thing in a way that makes sense to you and protects the public, consumers and investors’.”

Meanwhile, Jones conceded regulators “don’t have an easy task. Technology is developing too fast. Right now, regulators are struggling enough to understand the ordinary buy-and-sell crypto markets.”

Ozair agreed, adding that “When it comes to regulation, there’s no one-size- fits-all – whether it’s crypto services or DeFi, each one is different.”

“One concern is that regulators who fail the fully grasp the complexities of the industry might opt for one-size-fits-all solutions,” she warned

“Instead, regulators need to figure out how to do things in a flexible way to protect market participants and, at the same time, allow innovation to prosper. Not an easy task.”

Jones also emphasised that “There are stages to reach a fully decentralised place.”

“To get there, we’ll need centralised intermediaries along the way. We will not jump from a full fiat system to decentralised place overnight.”

In the meantime, governments and regulators should “get really involved, get their hands dirty.”

“Talk to the industry, cooperate with them. It’s the best way forward,” he said.

Overall, Dionysopoulos said that for DEFI to operate safely and efficiently while also fulfilling its huge potential, there would need to be public and private partnerships between DeFi platform providers, developers and regulators.

Along similar lines, Klesla noted: “One the one hand the system should be open to the 16-year-old from her parents’ garage and, on the other hand, we can’t afford major fraud cases or big losses of consumers’ money.”

Dionysopoulos said regulators will have to balance the risks relative to the rewards of DeFi in order to devise an effective regulatory framework.

One thing is certain, he said: lawmakers cannot avoid dealing with decentralised finance, the future of money.

 

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